West Penn Allegheny's financial troubles have worsened. In the past year, the health system saw credit agency Moody's drop its speculative credit rating on outstanding bonds, reported 400 job cuts and layoffs, and shuttered 59-bed Suburban General Hospital in Pittsburgh. It has $748 million in outstanding debt.
The deal doesn't mean West Penn is in the clear financially. Moody's said June 30 that it plans to take no immediate rating action. It said in a comment that the $50 million grant should bolster the health insurer's financial performance and liquidity, but long-term concerns include the integration of the organizations, Pennsylvania's “strict” regulatory environment and new competitors in the payer space.
The deal is also responsible for the departure of Dr. Christopher Olivia, president and CEO of West Penn Allegheny since 2008. Dianne Dismukes, the system's new chief of hospital operations, will succeed Olivia as president and CEO.
West Penn Allegheny executives said June 28, the day they announced the “affiliation agreement,” that West Penn Hospital would have been closed in September without a capital partner. West Penn Allegheny had already closed down the 500-bed hospital's emergency department and shifted some services to Allegheny General Hospital.
Dr. Tony Farah, who was named chief medical officer and executive vice president at West Penn Allegheny in June, said that while Highmark's profile, including its not-for-profit status, made it the system's first choice as a capital partner, it was prepared to investigate alternatives if the deal did not pan out.
In its 2010 fiscal year, Highmark reported $14.6 billion in consolidated revenues and $463 million in net income. It has nearly 5 million members in Pennsylvania and West Virginia, with roughly 3 million of those members in Western Pennsylvania.
Formal talks between Highmark and West Penn Allegheny began in the first quarter of this year, Farah said. “Had talks broken down, we would have looked for a for-profit alternative and West Penn (Hospital) could have stayed open,” he said. “It wasn't a definite.”
What was more definite was the need for capital. West Penn Allegheny's days cash on hand—a measure of its financial position—has steadily declined from 70.8 as of June 30, 2010, to 45.1 as of March 31. Its bond agreement states that the health system should have at least 35 days cash on hand at the end of its fiscal year.
Dan Laurent, a spokesman for West Penn Allegheny, said that days cash on hand did not drop below the 35-day threshold. He declined to provide information about days cash on hand before the deal's announcement.
Farah and Rice said Highmark's initial $50 million grant was not used to meet the bond covenant. Rice noted that a portion of the grant will be used to support West Penn Hospital and its Forbes regional campus hospital east of Pittsburgh, where UPMC is building a 156-bed hospital in the same region. The new hospital is expected to open in July 2012.
“Forbes Regional Health System is important to us because it is a real asset in the eastern part of that geography,” Rice said. “It's really critical that they remain viable and they need to be able to compete with UPMC and the new hospital they're building in the market.”
She added that Highmark will provide additional information about how the funds will be used within the next two months, the same time in which Highmark and West Penn Allegheny are expected to submit a regulatory filing to the Pennsylvania Insurance Department.
“Ultimately, we expect the (insurance) department will be one of the regulators that has a role in reviewing and approving the proposed arrangement between Highmark and West Penn,” Michael Consedine, state insurance commissioner, said in a statement. “We cannot formally comment, however, on the process and transaction until we have a filing, which we expect to receive sometime late summer.”
Pending regulatory approval, Highmark will be positioned as the state's largest insurer and Western Pennsylvania's second-largest health system even as it continues to pump money into West Penn Allegheny. Highmark officials said during a news conference that they expect the deal to close in the next six months.
UPMC officials say they are ready to compete with the new West Penn Allegheny. “You can argue that by acquiring West Penn Allegheny they are transforming themselves into a troubled hospital system,” UPMC spokesman Paul Wood said.
He added that UPMC has “enhanced and expanded” its insurance contracts with Aetna, Hartford, Conn.; Cigna, Philadelphia; HealthAmerica, Harrisburg, Pa.; and UnitedHealthcare, Minnetonka, Minn. As a result of Highmark's affiliation with West Penn Allegheny, all UPMC physicians and hospitals will be available to the insurers and their members.
“There will be a lot more choice and competition in the health insurance market in Western Pennsylvania,” Wood said. “This has been a market that's long been dominated by Highmark and closed to outside competition.”
If the deal moves forward, Highmark will likely develop an “enterprise board,” which would separate the reporting lines for the health insurer's provider partners, such as West Penn Allegheny, and its payer operations.
Rice said the company's provider partners, which would fall under a “provider delivery system board,” could include community hospitals, independent physicians, or multi-specialty practices. Highmark currently does not own any hospitals or health systems. “Anything that we do own or have equity in would be governed under this provider delivery board,” she said.
The shift in the dynamic between hospitals and health systems and their capital partners, as well as an insurer's decision to enter a market scarcely populated by competitors reflects a changing national climate. “You've got an insurer purchasing a healthcare system and that is highly unusual,” Cyganowski said. “The activity we've seen to date in the insurer sector: purchasing physician practices, employing physicians, purchasing physician support companies. They've not taken the big step of jumping into the healthcare delivery space.”
West Penn's Farah said that because of the scale of Highmark's market share in Western Pennsylvania—the health insurer manages about 65% of the regional health insurance market while UPMC's health plan makes up about 15%—West Penn Allegheny and Highmark will have enough clout to change the reimbursement model.
“We can go to the physicians and go to the hospitals and say, ‘We're going to start reimbursing based on quality metrics, outcomes, and also based on cost effectiveness,' ” Farah said. “All of a sudden, that incentive of being volume-driven completely goes away.”