Hillcrest HealthCare System wasn't at the bottom of a hole, but it wasn't where Don Lorack wanted it to be either.
Lorack, president and chief executive officer of the Tulsa, Okla.-based 13-hospital system, said he knew Hillcrest needed to post 4% or 5% margins to meet its financial goals: investing in its hospitals, refunding its debt and building its balance sheet. In the 12 months ended May 31, Hillcrest posted net income of $6 million on net revenue of $474.4 million, or a 1.3% margin.
"We weren't concerned about the short term," Lorack said, "but the long term."
The first quarter of 2003 forced Hillcrest's board to discuss the system's long-range strategic needs, Lorack said. More uninsured patients and the shifting of costs to patients by employers and health plans were driving up Hillcrest's bad debt. That discussion led to the eventual sale of 10 of Hillcrest's hospitals to investor-owned Ardent Health Services, Nashville, for $281.2 million in a deal that closed earlier this year.
The Hillcrest conversion deal is just the biggest symbol in 2004 of a steady uptick in the percentage of hospitals owned or leased by for-profit operators. Investor-owned companies operated 16.1% of the nation's community hospitals at the end of 2003, the highest percentage the American Hospital Association has recorded in its annual statistics, which date back to 1975, when 13.2% were investor-owned.
At 790, the number of investor-owned hospitals in 2003 is just 15 higher than the number in 1975, and well below the peak of 834 recorded in 1986. But the number of all hospitals in the country has dropped by one-sixth since 1975, with public hospitals down more than a third and not-for-profits down more than 10%, according to figures published in Hospital Statistics 2005 by AHA subsidiary Health Forum.
Those figures also showed that the overall number of hospitals continued a long-term decline in 2003, falling by 32 hospitals to 4,895, a 2.1% decline. In 2002, the number had increased 0.4%, up by 19, to 4,927, the first time that the number of community hospitals had risen since the AHA began tracking the statistic in 1975 (Jan. 12, p. 6). It appears that the 2002 figures may have been just a blip, however. The overall number has stabilized around 4,900 since it fell by 41 hospitals, or 1.2%, from 1999 to 2000, and industry observers say that that figure is likely to remain relatively stable or decline slightly in coming years.
One underlying factor could be that the smallest hospitals are becoming less viable, said Jack Zwanziger, professor and director of the health policy and administrative division for the School of Public Health at the University of Illinois at Chicago. More patients are within driving distance of larger hospitals, which they seem to prefer. "I don't know that there's as much of a commitment to small, community hospitals as there used to be," he said.
This year, conversions of not-for-profit hospitals to for-profit hospitals are outpacing conversions in the other direction by 21 hospitals to 10.
Also, unlike the late 1990s, when the former Columbia/HCA Healthcare Corp. was selling hospitals back into the not-for-profit sector, Tenet Healthcare Corp.'s divestitures have gone mostly to other for-profit operators, both established and start-up companies. Of the 14 hospitals Tenet divested in 2003, it sold 11 to for-profit operators and one to a not-for-profit that converted the building for other uses. Tenet closed two of the hospitals. Tenet has sold or agreed to sell 20 of the 27 hospitals on its 2004 divestiture list, and 18 of them are going to for-profit buyers.
Specialty hospitals, which are included in the AHA figures, have driven some of the jump in the investor-owned ranks, said Caroline Steinberg, the AHA's vice president of trend analysis. In 2002 and 2003, 19 and 27 specialty hospitals opened, respectively, Steinberg said. While admissions and population are growing across the country, they are growing faster in the Sun Belt, where investor-owned chains are concentrated, she said.
Capital still key
Many of the same factors that explain this slow climb of investor-owned hospitals were cited when Modern Healthcare first reported on the issue more than 18 months ago (March 17, 2003, p. 52).
The biggest factor remains access to capital-investor-owned chains have it, while access is much more varied for not-for-profit systems, said Martin Arrick, managing director of not-for-profit healthcare at Standard & Poor's. Many of the broad measures of credit quality, such as annual median figures for profitability and debt coverage, are solid, Arrick said. "When you look past the medians, you see a more complicated picture," Arrick said. "You're seeing a real split in credit quality. Many are doing better than ever, but that prosperity is not uniform throughout the sector."
Meanwhile, even as their margins are squeezed by bad-debt expense, investor-owned companies are attracting both equity and debt capital. LifePoint Hospitals lined up $1.7 billion to finance its purchase of Province Healthcare Co., which is expected to close in the first quarter of 2005. Iasis Healthcare Corp. and Vanguard Health Systems both attracted private equity firms to recapitalize the companies. Even Tenet, despite its legal and operating issues, was able to sell $1 billion in bonds this year to refinance debt.
The capital advantage could be all the more valuable because several other factors look to bode ill for all hospitals, Arrick said.
Hospitals are in a Catch-22 regarding reimbursement rates from commercial insurance companies, he said. Hospitals have come to rely on higher rates, but that has prompted insurers to push for double-digit percentage increases in premiums from employers. If that growth rate continues, employers may drop coverage or push more of their costs onto employees, signaling even more bad debt for hospitals, Arrick said. If the insurance companies lower the premium increases, however, they won't be able to boost reimbursements the way hospitals have grown accustomed to, he said.
The other side of the unpaid-care coin-charity care-is also a concern, Arrick said. The pressure is now building on not-for-profit hospitals with the spate of class-action lawsuits filed across the country, the same kind of pressure that activists put on for-profit chains starting in 2002.
Reimbursements from government programs are also questionable. Medicaid spending has been tightened in states across the country. Medicare has been a solid payer and will be through federal fiscal 2005, which ends Sept. 30, 2005, Arrick said, but with the Medicare drug benefit starting in fiscal 2006, "There's a feeling that the money will come from providers, and the biggest bucket is hospitals."
While large transactions such as Hillcrest and HCA's purchase in 2003 of Health Midwest, Kansas City, Mo., draw the most attention, it's the steady rate of converting rural hospitals that seems to be having a bigger effect, said David Atchison, managing director at Ponder & Co., a financial adviser of not-for-profit hospitals. Ponder advised both Health Midwest and Hillcrest, but those deals are not the norm, Atchison said.
Besides their poor access to capital, stand-alone rural hospitals have a tough time recruiting physicians and obtaining cost-effective support services, Atchison said. Rural investor-owned chains can offer better financial packages to physicians and make quicker decisions when recruiting; they also typically bring a standard platform of information technology and support services to hospitals they acquire.
When these hospitals come up for sale, not-for-profits are less interested in buying them than they were a decade ago, Atchison said. Not-for-profit systems are focused on core operations, and the hub-and-spoke strategy of owning outlying hospitals to drive referrals has been discredited, leading many systems to unwind their larger regional networks over the past seven or eight years, he said.
The greater prevalence of investor-owned hospitals could conceivably play a role in the debate on the tax-exempt status of not-for-profit hospitals, said Zwanziger of the University of Illinois. "I think one of the issues is that if you look at the differences in behavior, there are differences, clearly, but they're subtle," he said. "They're not as obvious as if (for-profit hospitals) didn't provide any uncompensated care."
Since not-for-profits still dominate both the overall hospital landscape and most individual markets, that could be constraining for-profit behavior, Zwanziger said. The expectations are that hospitals, no matter what their tax status, will cover much of the cost of uncompensated care. "I think it's true that the onus is on not-for-profits to show that they are acting differently, that they are contributing to the community in some way that justifies their tax savings," he said.
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