Next month marks the seven-year anniversary of the collapse of the Allegheny Health, Education and Research Foundation, a development that shattered the hospital marketplace in Pennsylvania's two largest cities.
The wounds incurred by the largest healthcare bankruptcy in history are nearly mended, yet reminders of those dark days still pop up unexpectedly, even though nobody likes to talk about it much.The most recent reminder surfaced in April with the release of the Pennsylvania Health Care Cost Containment Council's annual financial analysis of hospitals. Financial margins at hospitals statewide were dragged down by unusual charges posted by Tenet Healthcare Corp., according to the report. The for-profit hospital chain, which has suffered its own troubles independent of AHERF in the past several years, traces its entry into the Philadelphia market directly to the AHERF bankruptcy. Tenet scooped up eight formerly AHERF-owned hospitals in 1998 for the bargain-basement price of $345 million.
"I think definitely the lesson (from AHERF) is that no matter how great you think (a turnaround strategy can be) certain hospitals can't be turned around," says Dan Grauman, president and chief executive officer of DGA Partners, a healthcare management consulting firm in Bala Cynwyd, Pa. AHERF's entrance into the Philadelphia market and Tenet's subsequent acquisition of the bankrupt hospitals "probably prolonged the lives of some of these hospitals," Grauman says.
Unlike in Pittsburgh, AHERF was more than a temporary diversion in Philly and it left some scar tissue there. "I don't think there is any question that the AHERF bankruptcy and debacle cast a cloud over Philadelphia hospitals and their ability to issue debt and generate capital," Grauman says. Some hospitals and health systems have bounced back, "But I think it took a while to regain credibility in the marketplace."
In the years since its entrance into Philadelphia in the wake of the AHERF fiasco, Tenet shuttered three of the eight Philadelphia affiliates of AHERF-City Avenue Hospital, Parkview Hospital, and most recently the Medical College of Pennsylvania-and sold a fourth, Elkins Park Hospital, to not-for-profit Albert Einstein Healthcare Network. Tenet acquired a fifth, 125-bed Roxborough Memorial Hospital in late 2002, for a net loss of three hospitals since Tenet loosened the stranglehold not-for-profits maintained in Pennsylvania. Since Tenet broke through that barrier in 1998, a total of 22 hospitals converted to for-profit status, and 19 are still operating that way, according to the state's analysis.
Regaining their strength
Twelve of the 17 hospitals that operated as for-profit organizations for all of fiscal 2004 posted better total margins than they did during their last year as a not-for-profit, according to the Cost Containment Council.
Total financial margins at hospitals statewide-which sagged in 1999 after the bankruptcy to negative 0.27%-are on the rise, according to the report, but they could have been even better if not for Tenet. Margins grew more than a full percentage point to 3.37% in fiscal 2004 from 2.3% in the previous year, primarily driven by a rise in non-operating income with gains in the value of many hospitals' investments. On the other hand, the statewide operating margin fell to 2.1% from 2.16% during the same period, but like total margins, it was "significantly affected" by Tenet, according to the financial analysis.
Tenet's adjustment of the "book value" of its assets to account for merger, impairment and other unusual charges-recorded as an expense-lowered the statewide operating income by $111.3 million in fiscal 2003 and $85.6 million in fiscal 2004, according to the Cost Containment Council. That represented a significant chunk of the $528 million in operating income Pennsylvania hospitals collectively recorded in 2004, a $24 million gain from the previous year.
The Philadelphia market took the most visible beating from the AHERF bankruptcy, even though the 14-hospital system, with its flagship Allegheny General Hospital, was deeply rooted in Pittsburgh. The bankruptcy's legacy to its hometown is the now four-hospital West Penn Allegheny Health System, which rose from the ashes of AHERF, financed with $476 million in junk bonds priced at yields as high as 9.7% for uninsured 30-year notes. The debt funded the merger of AHERF's four Pittsburgh affiliates with two-hospital Western Pennsylvania Healthcare System to form West Penn. No Pittsburgh-area hospital suffered a bankruptcy as a direct result of AHERF, and the market has managed to keep for-profit hospitals at bay.
That contrasts with the five-county Philadelphia metropolitan area, where the landscape has dramatically shifted since acquisition-hungry AHERF came to the city, says Jerry Katz, president of the Katz Consulting Group in Plymouth Meeting, Pa. AHERF's aggressive move into the market set off a high-stakes bidding war for physician practices, hospitals and practically "everything that was an institutional provider of healthcare," he says. In the 1980s, there were 83 unattached hospitals in the Philly metropolitan area. Now Katz estimates that there are only seven independent hospitals left.
"I think some of the consolidation would have happened naturally, but what (AHERF) did was create an atmosphere where free-standing institutions were forced to look at becoming part of a system," Katz says. "They changed the whole competitive marketplace dramatically, and it happened very quickly. They were putting . . . a lot of outlandish offers on the table, and it really set in motion a lot of buying and selling."
Consolidation in Pittsburgh
The stark differences between the Philadelphia and Pittsburgh markets seven years after AHERF might simply rest in the fact that the Philadelphia market is more competitive, says Martin Arrick, a managing director at Standard & Poor's. Pittsburgh is neatly divided into three major players: West Penn Allegheny; the University of Pittsburgh Medical Center; and hospitals belonging to the far-reaching Catholic Healthcare East system, he says. UPMC is by far the dominant provider in the region while West Penn Allegheny is a much leaner system in terms of number of hospitals and ready cash.
West Penn Allegheny, created in 2000, continues to struggle, although it is now operating in the black under a change in leadership in 2003. Though not in the same league as UPMC, whose debt is rated A+ by S&P, West Penn Allegheny's speculative-grade B rating does have a positive outlook, Arrick says.
Five years after its creation, West Penn Allegheny finds itself in a tricky position, Arrick says. Its immediate issues, he says, include a large amount of long-term debt at a high interest rate attributable to the risky nature of its founding, significant pension liabilities and a pent-up demand for capital expenditures, which were deferred in the early years to preserve cash. The system "is really beginning to understand if (it defers capital spending) over a long period of time, it gets to be a problem. We're getting the feeling if they don't (invest in capital projects) it will become a competitive issue," Arrick says.
Jerry Fedele, West Penn Allegheny's president and CEO, says the key question isn't how former AHERF hospitals are faring seven years after the demise of the system, but how West Penn Allegheny is succeeding since its formation. None of the four former AHERF hospitals that were rescued were in bankruptcy, but the balance sheets were in shambles, physicians had defected, and their boards of directors were "being sued regularly," says Fedele, who was general counsel for Western Pennsylvania Healthcare at the time. "We saw an organization damaged very badly by AHERF, but we also saw an organization with tremendous value and a tremendous franchise underneath," he says.
Over the past year, West Penn Allegheny has consolidated two sets of hospitals to achieve greater efficiencies. Fedele says unless the wide gap between long-term and government interest rates closes, it would not be worthwhile to re-finance its expensive debt before the first call date of 2010. Nevertheless, he insists that the system will meet its financial challenges, fulfilling its pension obligations and putting together a capital spending plan that commits from $60 million to $80 million per year going forward. In 2004, the system committed $75 million to capital projects such as "cutting edge" imaging equipment; a new electrophysiology laboratory at Allegheny General; and a new catheterization laboratory at Western Pennsylvania Hospital, Fedele says. This year the system will commit as much as $65 million to capital projects.
"I think we've made just tremendous progress," Fedele says, noting that the four hospitals that had been affiliated with AHERF collectively lost $90 million in 1998. Following a "very detailed and methodical" business plan, the system turned profitable with $18.5 million in income in 2004-a $110 million swing, he says. Admissions are up more than 10% over the five-year period and market share has grown to about 23% from 20%, Fedele says.
If AHERF had never happened, Allegheny General Hospital would be "the same pre-eminent, dominant institution it is today," Fedele says. AHERF was a terrible episode, "but I think it was a temporary diversion." Still, a health system doesn't experience turmoil like that without teaching some significant lessons, he says. Those lessons center on governance and leadership. No one person ever had a complete picture of the sprawling system with its dizzying array of corporations and boards of directors, he says. "Because of that there was no effective oversight or stewardship and when things started to go bad, you had managers making decisions and guiding it when it should have been the board. From a national perspective, AHERF is still brought up "as an example of what not to do," Fedele says.
Staying competitive in Philly
The attitude toward AHERF is not quite so philosophical in Philadelphia, where the hospital marketplace has changed significantly because of what happened to the system, says Liz Sweeney, a director in healthcare ratings for S&P. During those first few years of Tenet ownership, the Philadelphia affiliates were stabilized and in the years since, Tenet "has really started to rationalize those assets," she says. With three of its former AHERF facilities in Philadelphia now closed and a fourth sold, Tenet is "no longer considered a substantial player," with only about a 7% market share in the five-county area, Sweeney says. Philadelphia in general is not nearly as consolidated as Pittsburgh, she says.
But Tenet believes its remaining Philadelphia hospitals are finally in a position to be successful over the long term in the competitive market. The company's biggest challenge in acquiring the AHERF hospitals was the lack of capital investment over a long period of time and "the lack of a viable market strategy against much larger competitors," Harry Anderson, a Tenet spokesman, said in an e-mail. "Several of the hospitals we acquired simply could not survive in today's marketplace; we said when we acquired the AHERF hospitals that we wanted to give each of them a full chance to demonstrate their viability. We did that by investing millions of dollars in them."
Grauman says Tenet's current problems nationwide, stemming from an inordinate reliance on Medicare outlier payments, are unrelated to its role as the white knight in the AHERF bankruptcy. Anderson agrees, saying Tenet's remaining hospitals "are making good progress in spite of the significant reduction in outlier payments since 2003."
AHERF helped set off an ill-advised battle for primary-care physician practices at what many thought were outlandish prices. Always a cautious community, Philadelphia hospitals and health systems are now even more gun-shy about acquiring physician practices, getting into risk-sharing ventures with insurers, or even participating in pay-for-performance programs, Grauman says. Elsewhere, physician practice acquisitions seem to be re-emerging as a national trend among hospitals (June 13, p. 4).
More than just a blip in Philadelphia, AHERF's legacy is that, like the economy in general, "hospitals that are doing well are doing very well and the hospitals that are doing poorly are doing really poorly," Katz says.
For example, the Medical College of Pennsylvania, a 155-year-old institution that was at one time associated with the first and only women's medical school in the country, died a tortured death earlier this year. The college was a former AHERF affiliate that Tenet slated for closing until state officials and a physician-led management team stepped in to revive it. The effort failed, removing a storied hospital from the Philadelphia roster. Only now are some Philadelphia hospitals beginning to regain their ability to raise capital in the bond markets. Meanwhile, the residual effects of the AHERF bankruptcy coupled with the state's malpractice problems have made physician recruitment almost impossible in Philadelphia, he says.
"Just put a big, black ribbon around the story," Katz says.
Yet despite the trauma that some hospitals incurred, others found a silver lining in AHERF. Katz notes that UPMC "really amalgamated to deal with AHERF" and its dominant position in the Pittsburgh market is "attributable at least in part to Allegheny's (AHERF's) failure."
In Philadelphia, Albert Einstein Healthcare Network snapped up Elkins Park Hospital from Tenet in 2003. Einstein acquired a choice 30-acre parcel of rolling green hills on which to relocate its MossRehab for a mere $12 million, a deal that included $4 million worth of equipment and supplies, says Barry Freedman, Einstein's president and CEO. Before the purchase, Einstein estimated it was going to cost nearly $50 million to renovate Moss at its old site next to the system's flagship, 701-bed Albert Einstein Medical Center. Freedman estimates the system saved close to $25 million and also gained some medical-surgical beds for Einstein.
"It worked out better than good; it worked out great," Freedman says.
Arriving in the Philadelphia market from New York only two years ago, Freedman says AHERF is not something he has heard discussed very much. The ramifications can perhaps be seen in "a little more caution, a little more distrust." The hospital industry has learned not to blindly trust hospital management, "which plays into (the city's) Quaker strength," he says.
Nationally, the bankruptcy caused everybody to be "more conservative and much more diligent. I think it awakened boards and put a shudder in some executives that might be control freaks, so I think there might be some positive that came out of that catastrophe," Freedman says. "We learn from our mistakes, and that was a colossal mistake."
What do you think?
Write us with your comments. Via e-mail, it's [email protected]; by fax, 312-280-3183.