Last summer, Middlesex Hospital officials traveled from Connecticut to Maryland to meet with Suburban Hospital executives who had recently decided to no longer go it alone.
The few, the proud . . .
… the stand-alone hospital. Some solo hospitals say they can withstand the sour economy and respond to reform quicker and more successfully
Johns Hopkins Health System acquired Suburban Hospital in June 2009. The visit was one of two to help Middlesex executives and directors decide if their independent, midsize hospital could continue solo or whether they too should seek the market clout and capital access that typically comes with size through a merger or acquisition.
The answer? No deal, said Vincent Capece, Middlesex Hospital's senior vice president and chief operating officer.
Independent hospitals across the country are wrestling with a similar decision, which healthcare executives, analysts and financial advisers say has grown more urgent as the economy continues to drag and health reform seeks to curb spending on hospital care, while the law increases demand for costly investments in technology and physician employment.
This comes at a time when weaker, solo hospitals have found capital more costly than they did in the years prior to the credit crisis. Deals for independent hospitals accounted for an unusually high share of the announced mergers or acquisitions in 2009: 44 of the 52 transactions, according to Sandy Steever, editor of Irving Levin Associates Health Care M&A Information Service, which tracks deals.
But some free-standing hospitals say they can do without partners (for now, at least) thanks to strong finances, unique markets, or the chance to strike other less-demanding deals that may improve operations. Executives say any possible benefits from a merger or acquisition—such as defraying overhead costs, gaining leverage with vendors and insurers, and having greater access to capital—do not do enough to compensate for the loss of local control when solo hospitals are acquired by health systems or merge with larger partners.
“You don't get something for nothing,” said Capece, who will become Middlesex Hospital's president and CEO in September when Robert Kiely retires. “The whole issue of control was something that was very important for the board. It was a difficult thing for them to consider giving up control in exchange for what might be the potential for advantages in the long run. The potential advantages weren't hard and fast. They weren't guaranteed.”
Kiely said the board considered the risk that a larger organization may not have the same speed or flexibility to respond to health reform.
Hospital deals this year will likely keep pace with or exceed the 52 hospital mergers or acquisitions announced in 2009, Steever said.
Through June, 23 deals had been announced, including a dozen deals for stand-alone hospitals. Among the remaining 11 transactions are two noteworthy for-profit acquisitions of not-for-profit health systems: Vanguard Health System's deal for Detroit Medical Center, and Cerberus Capital Management's bid for Caritas Christi Health Care (April 5, p. 6).
But Steever said he does not expect a repeat of the high share of deals for stand-alone hospitals seen last year (85% of all announced transactions), when the Great Recession and capital constraints likely led some distressed hospitals into deals that had to be done, he explained.
Overall, solo hospitals' financial performance improved in fiscal 2009 compared with fiscal 2008, according to figures released last week by Standard & Poor's. The credit rating agency's review of more than 550 independent hospitals' finances found the median operating margin rose to 2.3% from 1.8% the prior year.
But it's unclear how long hospitals can sustain those gains. Last year's improvement came not from growth, but from higher payments from insurers and hospital cost-cutting, said Suzie Desai, an associate director in public finance for Standard & Poor's. Hospitals temporarily froze salaries and benefits and adopted more lasting cuts to staffing. Should volume remain flat, it's uncertain that hospitals can find further cuts. Meanwhile, many cut back on capital spending to protect cash reserves, which cannot last, she said.
Middlesex Hospital reported a strong operating margin in 2009 because management scaled back spending in anticipation of a drop in volume that did not materialize, Capece said. The hospital had no layoffs but did curb spending on overtime and benefits. That strong performance continues, which leaves Middlesex without the motivation that drives many merger or acquisition deals, he explained. “There are a lot of hospitals out there that are losing money,” Capece said. “They are looking for a lifeline.”
That's true for New Milford (Conn.) Hospital. Last summer, the 62-bed hospital began talks with its larger, financially stronger neighbor Danbury (Conn.) Hospital, roughly 16 miles to the south. In early June, the partners announced a binding agreement to create a two-hospital system under a newly created parent company.
New Milford closed 2009 on its worst-ever operating loss as fewer patients sought medical care during the economic downturn, said Richard Henley, a consultant hired as interim chief executive during the negotiations.
New Milford reported a negative operating margin of 5.91% last year, one of six Connecticut hospitals to report operating losses in 2009, according to the state Public Health Department. Meanwhile, Danbury Hospital closed 2009 with a 5.17% operating margin. After investment and other nonoperating income were included, Danbury Hospital had a net margin of 8.01%, higher than any other hospital in the state, the agency said.
Small hospitals have less leeway to cut fixed costs when volume drops compared with large systems with higher numbers of patients, Henley said. New Milford Hospital's governing board decided access to capital for technology or to attract doctors hinged on a partner.
Health reform also factored into the decision as the board considered the resources required to create an organization able to qualify for newly created Medicare payment models under the law, Henley said.
Health reform is expected to squeeze margins regardless of hospital or health system size, said Mark Grube, a partner with healthcare financial adviser Kaufman Hall and head of its strategic advisory group. “The main challenge with stand-alones is what they're able to do about it,” he said. Hospitals that have exhausted cost cuts in labor and supplies have begun evaluating money-losing services as potential cuts. To achieve savings beyond that likely requires the scale that comes with health systems, he said.
But pressure to merge will also vary by each market, financial consultants said. Solo hospitals in more competitive, less consolidated markets may find it more difficult to remain independent than more insulated hospitals, said George Whetsell, a managing director with Huron Consulting Group's Wellspring and Stockamp group. Whetsell said he does not expect an increase in consolidation but instead that more hospitals will focus on improving financial performance for reform provisions that tie payment to quality.
In the Seattle area, Overlake Hospital Medical Center continues to operate independently, despite consolidation. “The most vulnerable hospitals are private, independent community hospitals with independent medical staffs that do not have any public support from tax dollars,” said Gary McLaughlin, Overlake's vice president of finance and chief financial officer. “We are the last of those in Seattle.”
Nonetheless, Overlake Hospital officials believe their stand-alone hospital remains viable solo, because of strong operations and finances that will allow the hospital to make capital investments necessary to ready for health reform. Eighteen months ago, Overlake Hospital began a $65 million installation of electronic health records. The hospital employs 40 doctors but is expected to increase that to at least 125 in the next three to five years, he said.
McLaughlin said clout with insurers that would come from joining a health system would raise costs for local employers and Overlake may have some leverage with commercial payers should health reform squeeze reimbursement as expected. Insurers may have an interest in supporting Overlake to prevent future consolidation, he explained.
Overlake Hospital has been approached by area systems since the credit crisis and health reform, McLaughlin said. “We have standing invitations from a number of systems that we maintain dialogue with,” he said. “If we ever want to talk to them about becoming part of their system, they would love to talk to us.”
Others are seeking less-involved contracts or arrangements to boost services or cut costs, though they have not completely rejected future mergers or acquisitions.
In Missoula, Mont., officials at the Community Medical Center see a chance to stay independent by striking deals with larger hospitals or systems to bring specialists to the hospital. The 143-bed hospital holds such agreements already with Seattle Children's and the Billings (Mont.) Clinic.
Similar partnerships could better position Community Medical Center as public and private insurers begin to shift toward lump payments to treat conditions, rather than reimburse for each procedure, visit or test, he said.
President and CEO Steve Carlson said the hospital has better access to credit, which also helps bolster its independence, after a financial turnaround helped raised its credit rating in February to an investment grade BBB- from a more speculative BB+ from Standard & Poor's. The rating allowed the hospital to develop a financing strategy for a $17 million expansion, he said.
Community Medical Center saw fewer hospitalized patients and laid off 50 employees in fiscal 2010, which ended June 30. The cuts and ongoing efforts to boost outpatient services contributed to the hospital's 5.1% operating margin last year, on par with 2009, he said.
“Having a meaningful level of local control is something we'll always value,” Carlson said. “As we partner, we know it won't be absolute, but it will always be a critical element.” He won't rule out a possible future deal but said officials decided the community is best served by retaining local control.
No suitors have approached Floyd Memorial Hospital and Health Services, nor has the New Albany, Ind.-based hospital considered a merger. At least, not yet. “I think that over time, we will,” said Ted Miller, vice president and finance chief for the county-owned hospital.
But first the 194-bed hospital will work with a group of southern Indiana hospitals to jointly purchase services such as laundry or transcriptions to cut costs. Floyd Memorial officials will then compare results with potential benefits of pairing up, he said.
Health systems have economies of scale to their advantage, which credit ratings agencies value, he said.
Standard & Poor's nudged the outlook for Floyd Memorial's A- rating upward to stable from negative in January, in part because of its rebounding cash reserves and expanding market share.
Miller credits the expanded market share in part to Floyd Memorial's increase in employed doctors—a costly strategy partially offset by prior group purchasing efforts that yielded $4 million over two years (an effort to improve bill collection produced another $4 million during the same period).
For now the hospital is looking for chances to reap the advantages of scale without a merger. He said Floyd has not finished its analysis of how health reform may alter its operations and finances.
Not everyone has been motivated by the financial markets and reform.
All Children's Hospital began a search for a university partner three years ago—before the credit crisis, or health reform—to boost clinical research and medical education at the St. Petersburg, Fla.-based hospital, said its President and CEO Gary Carnes. Last week, Johns Hopkins Health System, Baltimore, signed a nonbinding letter of intent to acquire the 216-bed hospital.
Carnes said the hospital did not suffer from limited access to capital. He cited as evidence the hospital's strong credit (A1 from Moody's Investors Service and AA from Fitch Ratings) and recently constructed replacement hospital. He said health reform did not factor into the acquisition either, but the deal may prove to be an advantage under the law's efforts to overhaul payments.
“Maybe,” Carnes said, “it was a stroke of dumb luck."
Send us a letter
Have an opinion about this story? Click here to submit a Letter to the Editor, and we may publish it in print.