“We don't know what their limit would be,” said Steve Zaharuk, senior vice president of Moody's Investors Service's U.S. insurance team. Such a sizable investment will make it difficult to walk away or say no to further cash infusions if the system continues to struggle, he said. And until Highmark receives a regulator's final approval for the deal, the insurer cannot fully assess West Penn Allegheny's operations or pursue strategies that may turn the system around.
Highmark's deal for West Penn Allegheny won approval in recent weeks from a Pennsylvania court, but consent is also required from the state Insurance Department, which in late January noted Highmark's heightened risk and said a review would likely last until early April, at least.
The longer the review, the greater the delay to efforts by Highmark to turn around West Penn Allegheny, say credit analysts. “Time gets short,” Zaharuk said.
West Penn Allegheny's chronic losses accelerated last year as it hemorrhaged $112.5 million on operations, unaudited figures show. Saddled with debt and unable to generate necessary cash, West Penn Allegheny's capital investments have lagged its larger, financially stronger rival in Pittsburgh, the UPMC system, said Lisa Martin, Moody's lead analyst for West Penn Allegheny.
West Penn Allegheny Health System's credit rating has fallen nearly as far as it can go, and now Highmark is at risk for a downgrade of its credit. Should the health system drain more than has already been committed by Highmark, the insurer's rating could drop more than one notch, Moody's warned. Standard & Poor's said the insurer also faces rating pressure should its financial investment to create an integrated delivery network grow.
Highmark has also pledged $260 million in a deal for 373-bed Jefferson Regional Medical Center, Jefferson Hills, Pa. The deal won approval from a Pennsylvania court and is expected to close by March 1. And in coming weeks, the insurer is expected to reach a definitive agreement with St. Vincent Health System, based in Erie, Pa.
Jon Reichert, director of insurance ratings for Standard & Poor's, said West Penn Allegheny's financial performance will be “our primary indicator” of the success of Highmark's strategy.
West Penn Allegheny's operations have only made a profit for a single year since the system was formed in 1999, according to Moody's. Losses narrowed in the early half of the last decade, and the system posted its only positive margin of 1.3% in 2005 before slipping back into the red. The system's margin last year was negative 7.2%. Any turnaround includes potential hazards. In entering a deal with a distressed company, Highmark risks closing the deal only to uncover problems that did not surface in vetting it, said Tom Cassels, executive director of research and insights for the consulting company the Advisory Board.
Turning around money-losing hospitals also hinges on the support of physicians and nurses, who can undermine efforts with a “vote of no confidence,” he said. Dissatisfied doctors may leave or direct patients elsewhere. Wholehearted commitment by management to turnaround strategies is also critical, he said.
Less tangible, but still important, is an acknowledgment of the risks from lenders or others with a stake in the results. Management must also clearly convey strategies to mitigate those risks to investors and others. “The reality is turnarounds don't happen overnight,” he said.
Trey Crabb, a managing director with Ziegler who oversees the investment bank's healthcare merger and acquisition division, said any deal also raises the risk that managers are distracted by the transaction from their primary business. Highmark's push to create an integrated delivery system will expose the insurer to new businesses, which are related, but still different, he said. The potential gain for such a risky investment is the chance that Highmark acquired West Penn Allegheny at a bargain, which would increase its value should the turnaround succeed, Crabb said.
Also important is the strategic benefit Highmark is seeking to gain as a rival to UPMC, which owns 11 Pennsylvania hospitals and has its own a health insurance unit, said Standard & Poor's Reichert.
Highmark's executives have repeatedly cited competition as the reason for its entry into healthcare delivery. “Paramount to our affiliation with West Penn Allegheny is preserving provider competition and choice in healthcare providers for the entire community,” Dr. William Winkenwerder, president and CEO of the insurer said in a news release in January.