Just as many hospitals are ridding themselves of unprofitable medical practices, a risky new strategy to win physician loyalty is gaining popularity: hospital-physician joint ventures.
Faced with falling incomes and tempting partnership offers from investor-owned companies, specialty physicians increasingly are asking not-for-profit hospitals to split revenues and development costs in some of the industry's most lucrative service lines.
Often, it's hard for hospitals to say no. The past decade has brought an explosion in single-specialty physician groups that are capable of directing large volumes of patients and capitalizing their own competing projects. Meanwhile, the disappearance of certificate-of-need requirements in some states has made it easier for physicians to open their own facilities. National companies such as Birmingham, Ala.-based HealthSouth Corp., Charlotte, N.C.-based MedCath and Houston-based U.S. Oncology offer equity deals to physicians. Many regional players are also active.
Although joint ventures have been around for years, their number and scope appear to have increased dramatically in the past couple of years. Cardiac catheterization labs, imaging centers, ambulatory surgery centers and even specialty hospitals are being created as joint ventures. Several heart-hospital joint ventures are under development by such groups as seven-hospital Baylor Health Care System in Dallas, Community Medical Centers in Fresno, Calif., four-hospital Community Hospitals Indianapolis and 19-hospital Carolinas HealthCare System in Charlotte, N.C.
Ken Mack, president of DMI Transitions, a Cleveland consulting firm that advises hospitals and physician groups on business collaborations, estimated that there are about 250 joint ventures between not-for-profit hospitals and physicians. He said it's easy for physicians to direct patients, particularly for outpatient services. "As a hospital, I'd be very worried about my doctors skimming off outpatient procedures that are profitable for me if I didn't have a joint venture," he said.
Warning signs ahead
Responding to the trend, one rating agency recently warned that the strategy could backfire for hospitals. In a report released in November, Moody's Investors Service said the risks of joint ventures for hospital balance sheets outweigh the benefits. Moody's said hospitals stand not only to lose revenue, but also to incur indirect debt obligations such as possible bailouts if the project fails. Hospitals may also alienate physicians who are not part of the joint venture, Moody's said (See box, p. 5).
Moody's analyst Lisa Martin compared the recent surge in joint ventures to the period of the mid-1990s when many hospitals effectively padded physician incomes by purchasing their practices at inflated prices and putting doctors on generous salaries that weren't necessarily tied to productivity. Many hospitals and systems lost millions of dollars before selling the practices back to physicians for pennies on the dollar, or dramatically restructuring them to reduce red ink. Martin likens both trends to "an indirect subsidy of the physicians."
For-profit joint ventures are more expensive to operate than not-for-profit facilities. Heart hospitals carry extra risk for hospitals and physicians because of their high price tags. A typical heart hospital costs at least $40 million, vs. less than $10 million for an outpatient facility.
In addition, inpatient joint ventures are being created, despite a 1999 bulletin by HHS' inspector general's office warning that arrangements that reward physicians for reducing hospital costs, known as gain-sharing, violate a section of the Social Security Act that bars paying doctors to reduce services to Medicare and Medicaid patients. The bulletin said clinical joint ventures, including specialty hospitals, could violate the law and subject their owners to civil fines. As of yet, there's been no publicly reported enforcement action against a joint venture, said Katherine Harris, a spokeswoman for the inspector general's office.
Still another risk is that partnerships that are meant to strengthen bonds with physicians could lead to conflict. As technology and market forces evolve, providers must choose whether to expand services within the joint venture or outside of it. For example, Columbus, Ohio-based Mount Carmel Health System's plan to build a new hospital has been stalled by a breach-of-contract lawsuit filed by physicians who are Mount Carmel's partners in a surgery center. The suit claims the proposed hospital in Lancaster, Ohio, would violate an agreement that bars parties in the joint venture from operating competing businesses.
Hospitals make their case
Hospitals that engage in joint ventures defend them as a way to attract new physicians and improve services.
Edward Hospital and Health Services in Naperville, Ill., which operates a 185-bed acute-care hospital, has five outpatient joint ventures dating to as long ago as 1993. Although the ventures have been profitable overall, they're also a mechanism to attract star physicians to the hospital's growing service area.
Joint ventures are an integral part of Edward's physician relations. President and Chief Executive Officer Pamela Meyer Davis said the hospital has about 700 physicians on staff, up from 150 in the late 1980s. "People are recognizing it's a good place for physicians to be," she said.
Edward officials also believe that involving physicians in operations improves patient care. When Edward was losing money on its women's center in the early 1990s, it asked a local physician group to step in and manage it. Two years later, the management agreement evolved into a 50-50 joint venture.
The group's president, Christopher Olson, M.D., who is the medical director of the Edward Women's Center for Health, said the joint venture hasn't generated profits for the physicians, who are still paying off a loan for their investment. But he said it has allowed the medical group to control the quality of care and tap into Edward's professional resources and reputation. "We're walking around with their (Edward) logos on our jackets, and that has helped our practice to be even more successful," Olsen said. The practice has expanded by two physicians.
Twice in 2000, however, the Illinois Health Facilities Planning Board rejected Edward's attempts to build a for-profit heart hospital with physicians. In November 2000, the state approved the hospital's alternate plan, to build a $44.9 million expansion for cardiovascular services on its own, without physician investors. It is slated to be completed late next year.
Likewise, Community Hospitals Indianapolis has recruited more than 100 physicians to its system as a result of five joint-venture surgery centers, said its president, Bill Corley. Not all of the physicians are investors. He said physicians like the fact that the surgery centers are operated by physicians. Critics "don't understand the environment in which we operate, in which physicians basically float the boat," he said.
The strategy is so successful that the Indianapolis hospital system plans to invest in surgery centers with other hospitals in adjacent states, Corley said. It also plans to elevate its No. 3 market position for cardiac services once it opens a $60 million joint-venture heart hospital next year.
Community Medical Centers in Fresno, Calif., expects to take business from a competitor, Saint Agnes Medical Center in Fresno, with its proposed 60-bed joint-venture heart hospital. It also intends to lure local patients who might otherwise travel to the San Francisco Bay area for care, as well as capitalize on a local population boom. "We do not believe we are carving out some of our existing market share and giving it out to the doctors," said the hospital's chief financial officer, Bill Grigg.
The Fresno partnership is already paying off in unexpected ways, Grigg said. Fresno Heart Hospital, an $86 million facility with 48 physician investors, isn't scheduled to open until 2003, but cardiologists who invested are sending more of their patients to Community rather than to competing hospitals, he said.
But not all joint ventures have succeeded. Some hospitals have shied away from the strategy, partly because of financial and legal risks.
An alternative partnership model that promises to reduce those risks is expected to debut next year. National law firm McDermott, Will & Emery and investment banker Merrill Lynch & Co. have been developing a structure that would allow physicians to participate in the financing and management of a facility while keeping its ownership with a not-for-profit hospital or system.
Two heart hospitals are expected to be financed under the model in the middle of next year. While one is a new project, the other is an existing venture that hasn't been profitable as a for-profit, said David Johnson, a managing director in Merrill Lynch's Chicago office. Johnson said the hospital and physician owners of the existing heart hospital hope that recapitalizing it with tax-exempt debt will shave the interest by 4% and reduce other costs. He declined to name either facility.
Robert Rosenfield, a partner in the Los Angeles office of McDermott, Will & Emery, said not-for-profit facilities cost as much as 20% less to operate than for-profit ventures because of lower financing costs, the avoidance of taxes, and participation in large purchasing organizations. The structure is also designed to avoid regulatory risks associated with gain-sharing arrangements. He said the not-for-profit structure offers physicians less potential income, but their return on the bonds can reach 12% tax-free if the project is successful.
Under the arrangement, the hospital establishes a separate tax-exempt organization to operate the facility. Instead of buying equity, physicians purchase high-yield subordinated bonds. The physicians also own a management company that controls how the facility is operated.
But it does give physicians full control over how the facility is run, which isn't always the case in a joint venture. "For a lot of physicians, that's very important. They want to know that the manager of a facility is going to jump when they say jump," Rosenfield said.