It was the season of divorce in the year of disappointment. The once-buoyant brides fidgeted in their lawyers' offices, wondering how they would make it alone.
Had one party behaved badly? Had they fought over money? Was it a phony union of equals? Was one Catholic and the other Baptist?
Or was it a marriage made at Moody's Investors Service, a loveless business deal lacking an emotional core? If so, it was time to reread the prenuptial agreement and the bond covenants. What, these battered brides asked themselves, did I ever see in a hospital like that?
The marriages known as Penn State Geisinger Health System in Pennsylvania, Optima Health in New Hampshire, UCSF-Stanford Health System in California and Baptist/St. Vincent's Health System in Florida are in the final stages of breakup. In another instance, a single hospital, St. Anthony's Medical Center, is pulling the rip cord to bail out of a system it doesn't love any more, the now inaptly named Unity Health in St. Louis.
These examples are just the vanguard. Hospital lawyers, strategic consultants, governance experts and credit analysts report that lots of their clients--no names, please--are taking a hard look at what the market hath joined together and wondering how man might rend it asunder.
The mass-merger movement of the 1990s, like so many business fads, has hit the wall and bounced off. Those combinations that weren't clearly thought through are collapsing under the weight of their own false assumptions, broken promises and managerial failures.
"There weren't the synergies there they expected," says John Fargnoli of Standard & Poor's, the New York credit-rating agency. "And gee--surprise, surprise--there were cultural differences.9
Now, the same battalions of dealmakers and consultants that put the systems together are busily engaged taking them apart. Unfortunately, the exercise is often like unscrambling eggs.
Behind the breakups. Here are some of the reasons system mergers are coming unglued: Financial goals couldn't be met. Cultures clashed. Academic medical faculties didn't want to surrender control to nonacademics. Roman Catholics wanted to enforce the Ethical and Religious Directives for Catholic Health Care Services. Too much money was being shipped from one body to headquarters, or vice versa. Clinical integration was thwarted. The merger became politicized, and the hospitals had to separate to mollify the community.
The factors that should have driven hospitals to merge include a common strategic vision, a commitment to implement that vision and a cultural compatibility that would enable the new organization to function.
But those factors haven't always been present, says Charlotte, N.C.-based Keith Korenchuck, co-chair of the health law group at Davis Wright & Tremaine. Some hospitals just followed the fad and never got around to restructuring the management, relocating services and rationalizing operations.
"From a legal perspective they're one entity," but that's about it, he says. Fortunately, some of these mergers "were built to take apart." Especially if there's a holding company parent, and several operating companies that never really integrated and can be easily disintegrated.
The pressures on system leadership are even greater during divorce than merger, says Morley Robbins of Arista Associates, a strategic consulting firm in Northbrook, Ill. "People do look up to these boards, that they made the best possible decision (in merging). Now they have to back away.
"It's tough for anyone to admit they made a mistake, but for a large system that has multicommunity influences, it casts a pall over the organization," he adds.
Dividing the assets. Once hospitals decide to divorce, the expense and aggravation pile up just as they do for a married couple. Here are some of the things that have to be broken apart: managed-care contracts, information systems, clinical protocols, medical staff, real estate and medical equipment, bond financing, and governance. Then there are all the back-office functions: human resources, marketing, planning, accounting, finance, purchasing.
Those latter parts are usually the first to be combined, and the most successfully, analysts say. Demonstrable cost savings have been realized here from many mergers. Duplicating such services when the systems unwind is not necessarily that hard, but it is expensive and genuinely wasteful.
In Manchester, N.H., the separation of Catholic Medical Center from Elliot Hospital, which formed Optima in 1994, is introducing $10 million in extra annual operating expenses that had been wiped out when they combined, says Doug Dean, new chief executive officer of Elliot. Replicating the software and hardware of the information system comes at a capital cost of more than $3 million. "It's for separate licensing and hardware as well as staffing. It's an operational expense of seven figures," he says.
Meanwhile, Catholic Medical Center, which was supposed to give up inpatient services when acute care was consolidated at the Elliot campus, spent $5 million last year and another $5 million this year just to bring the building back up to standards.
"A lot of it was painting and waxing floors, minor renovations, a facelift," says Alyson Pitman Giles, CMC's CEO. "This year we will embark on a master facility planning process" to determine what services need to be near each other in the facility.
The hospital has also invested a small fortune in market research to understand the community's view of the institution, and in advertising and outreach, to re-establish a separate identity and market presence. Many Manchester residents thought that the emergency room had been shut down and that the hospital was a ghost town.
None of these expenses would have been necessary had the community and the hospitals been able to overcome the cultural issues that torpedoed the merger. In the end, the community and the medical staffs were unable to accept a unified hospital that operated under the Ethical and Religious Directives: The abortion issue killed the merger.
In Giles' view, no one should have been surprised by that because the public was told before the merger that the two hospitals would continue to operate separately, but under one governance and managerial structure. However, after the deal was done, the new board decided to consolidate at one campus. The public felt betrayed, and the community, made up mainly of people of French-Canadian descent who are strongly Catholic, mounted a political campaign to defeat it through a referendum on whether the community should maintain two separate hospitals.
In August 1998, the Ernst & Young consulting firm predicted that both hospitals, once separated, would lose major amounts of money on operations. By 2003, under the total separation scenario, the hospitals would lose $34.1 million on operations, a study by the firm found. Under full acute-care consolidation, they would earn $1.6 million on operations.
"It has absolutely proved to be accurate," Dean says. Elliot's deficit is exactly where Ernst & Young predicted it would be.
Clinical clashes. But it's the clinical elements that turn out to be a merger's third rail.
"This issue of clinical integration, reallocation of services, is the most difficult and least accomplished area within mergers," notes Dan Grauman, a principal at Health Data and Management Solutions in Bala Cynwyd, Pa. "It's one thing when you consolidate the laundry and managed-care contracting. It's invisible to the patient and the physicians. Where your services are provided is another matter."
This fact--the impossibility of integrating clinical services--tripped up UCSF Stanford, Penn State Geisinger and Optima.
At the University of California-San Francisco, for example, the faculty was willing to be persuaded that a merger with Stanford Medical Center could be worked through. But the Stanford faculty was much more skeptical. Faculty balked when it came time to join the UCSF faculty in a risk-sharing arrangement. Although this was part of the original merger agreement, the medical faculty as a whole had never signed on to the idea.
That was the final twist that moved the president of Stanford University to withdraw from the merger last October. After spending $79 million since 1997 to put the hospitals together, the parties are now spending a comparable amount to take them apart.
Mergers like these are victims of insurmountable odds, says Potomac, Md.-based governance consultant Barry Bader. "Nobody should be surprised by failures like this. The challenges facing these organizations were so difficult that the chances of success were very small." In the corporate world, two out of three mergers fail to add value to the shareholders. "So we shouldn't be surprised that the same is true of healthcare mergers."
Indeed, mergers involving academic medical centers seem to have the lowest probability of success. "Most are starting to shake and come unstuck," says Frank Trembulak, chief operating officer of Geisinger Health System, now separated from Penn State. The centers don't seem willing to make radical changes in the traditional way of delivering medical education and paying for the supporting clinical enterprise.
In the case of Penn State's Milton S. Hershey Medical Center in Hershey, Pa., and Geisinger, in Danville, Pa., the merger had combined many back-office functions and some clinical areas. Laboratories were integrated, information systems were unified and some clinical departments had been joined.
It was straightforward enough to assign certain clinical leadership roles to medical faculty at Penn State, but those same faculty balked when the system wanted to assign leadership of other departments to Geisinger physicians, Trembulak says. It was argued that the moves would undermine the academic mission of the college of medicine.
C. McCollister Evarts, M.D., CEO of Hershey and dean of the Penn State University College of Medicine, remembers it differently. Academic health centers, he says, need to maintain a balance among education, research and patient care, "and that balance was lost in the merger. There was a feeling that the college of medicine should be segregated and put over here somewhere on the side, and that academic chairs did not understand the realities of today's marketplace. That is furthest from the truth."
The consulting firm McKinsey & Co. was brought in to advise on clinical restructuring. "They proposed that several of the specialties be located at Hershey," Evarts recalls, "and that was not well received at Danville," where Geisinger is based.
The system board became "dysfunctional," Evarts says, and Penn State decided it wanted out. Governance was structured through a board controlled 50-50 by Geisinger and Penn State, but Geisinger held the tie-breaking vote. It insisted that the university buy its way out of the deal.
To unwind the merger, Penn State was required to indemnify the system for the operations of Hershey from last Nov. 1 to June 30 of this year. "The global agreement allowed us to isolate operations of Hershey, which was going downhill financially, while the other element, Geisinger, could focus on the performance improvement efforts," Trembulak says.
Geisinger had contributed most of the management and infrastructure of the combined organization, so Hershey had to start from scratch. It had to establish new relationships with vendors for information systems and other services.
But rather than revert to its pre-merger status as part of the university, Hershey used the occasion to create a new corporation to house the clinical enterprise, which will report to the university. Several state-controlled academic medical centers have taken that step in recent years, such as the University of Kansas and the University of Colorado hospitals. The move usually permits greater managerial flexibility.
Penn State will also pay Geisinger $150 million cash at closing on June 30, Trembulak says. This covers sale of assets, accounts receivable and equipment. The university is paying certain other costs, such as re-establishment of the Geisinger brand name, on an ongoing monthly basis.
Trembulak, who served as COO of the merged organization before reverting to his previous role at Geisinger, sighs as he describes the three-year roller-coaster ride employees and management have taken. "The sadness of this is the lost opportunity, the contribution we could have made to the public by doing this well."
Yet at Penn State, Evarts reports, the faculty is energized. "They did not want to stay in the merger. The unwind was a tremendous boost in morale to employees and faculty."
The awful truth. But to hear a fully unsentimental version of what a system divorce means, talk to credit analysts in New York.
"We would take a close examination of how that hospital that's demerging contributed to the consolidated entity," says Jordan Mellick of Fitch IBCA. "What percentage did that hospital contribute to revenue, excess income, cash flow, or EBITDA (earnings before interest, taxes, depreciation and amortization)?"
If the system had a profit of 4% and the hospital that's withdrawing earned 8%, that would be a negative for the system's credit rating. If the withdrawing hospital represented 30% of total system revenue, that would also be a negative.
Mellick also looks at implications of the divorce for managed-care contracting. "If the disaffiliation by one hospital represented a loss in negotiating clout and marketing leverage, we'd view that negatively as well," Mellick says.
However, if the hospital that's pulling out was a weak performer, it would redound to system management's advantage, for two reasons, he says: first, no more drag on the bottom line. Second, it shows management's ability to act decisively to cut out a losing organization.
In fact, Fitch IBCA is working on a credit rating for the newly separate Geisinger Health System. The borrowing the systems did together will be assumed by Geisinger, and it's going to refinance the bonds, says Craig Kornett, of Fitch's healthcare group. "Their numbers through nine months are excellent. Once Geisinger is free and clear of Hershey Medical Center, they are free of $30 million to $35 million of dean's tax." The "tax" was actually payments the unified health system had made to support the teaching and research missions of the medical school.
Secondly, Kornett adds, Hershey is smaller than Geisinger. "Hershey is losing money (if you include the dean's tax), whereas Geisinger is making money. Those are two reasons right off the bat, from a financial perspective, that Geisinger is going to be a better credit."
Geisinger alone earned $91.4 million in 1997. In 1998 the merged organization made $12.5 million, and in 1999 it lost $6.6 million. "When you go from making $90 million to breaking even in two years, that wasn't acceptable to the Geisinger people," Kornett says.
Lifetime commitment. What makes a system work? A no-exit strategy from the get-go, answers Richard Brown, president and CEO of Health Midwest, a 16-hospital system based in Kansas City, Mo. From the initial hospital combination in 1991, Health Midwest was designed not to be taken apart.
"We made irreversibility a foundation," Brown says. "If you have doubts whether this is the right step to take, neither we nor you should go through with it. We're committing ourselves to be together in a healthcare organization that will serve the city, not to preserve intact the status quo of any individual institution."
That philosophy has served the system well. None of its constituent hospitals has attempted to bolt, and certain others that might have merged decided to remain independent and instead participate in joint ventures and managed-care contracting.
Health Midwest's "sole member" structure gives the system board authority to appoint the boards of all subsidiary organizations. If the subsidiary board wanted to secede from the system, the parent would terminate that board and appoint a new one.
"That's the nuclear weapon you never want to fire," Brown says. "Management has an accountability to identify stress points. We have to listen carefully for folks who don't like what we're doing, and point out compromises and strengths."
Last year, the system faced the test of closing down a redundant hospital, Park Lane Medical Center in Kansas City, Mo. The system transferred Park Lane's employees and retained the patient base at other system hospitals.
"We ended up with a board of directors we didn't need anymore, a legal entity we didn't need anymore and a building that was empty," Brown says. "It was hard for that board to recognize that there was no further need for that hospital. But they were out of cash. They couldn't sell themselves or extract themselves from our system."
Brown calls that the "fight or flight" instinct. Systems have to agree upfront that constituent hospitals won't try to take wing every time they lose on a difficult integration issue. "In many of the mergers, it appears they didn't close off the flight option," Brown notes.
Ironically, when systems divorce, sometimes the unlikeliest people decide they don't want a divorce after all. At Optima, the medical staff integration has survived the hospital system.
"Optima is about the most scrambled egg of all the examples," Elliot Hospital CEO Dean explains. "We have merged all our clinical functions. There is one hospital-based group for radiology, one for emergency medicine, one group for pathology. It became one organization with two operational sites."
In the midst of the cultural wars and an acrimonious divorce, the physicians voted to remain a single medical staff serving two separate hospitals. There is one executive committee, one chairman of each major department, one structure of committees.
In hospital system mergers, usually it's the doctors who refuse to get along.
What the New Hampshire doctors are saying, in Dean's view, is that "as a medical community, we have experienced the advantage of a system model and a cooperative model, and we don't want to give it up."
An object lesson for hospital administrators everywhere.