Competing for kids: Children's hospitals face challenge from emerging megasystems

Over many decades, the stellar reputation of Monroe Carell Jr. Children's Hospital at Vanderbilt allowed it to corner the central Tennessee market for specialty services for children with highly complex healthcare needs.

But three years ago, its Nashville neighbor, TriStar Centennial Women's and Children's Hospital, began making its own push to expand its pediatric service offerings. The HCA -owned facility opened a new pediatric intensive-care unit and started recruiting pediatric specialists. It introduced Kids Express, an outpatient concierge-style service center providing respiratory and intravenous therapy as well as laboratory and imaging services.

The intensified competition has pushed both organizations to launch dueling marketing campaigns in places such as day-care centers and preschools across the region.

Vanderbilt isn't alone among children's hospitals in facing heightened competition in the pediatric-care market. “We're seeing a number of regional systems that want to build their pediatric capabilities even in areas where there's an established children's hospital,” said Mark Grube, managing director at consulting firm Kaufman Hall. “They want to keep more services in-network.”

In the past, most general hospital systems didn't have enough patient volume to support the large number of pediatric subspecialties required to offer a comprehensive service line. But megamergers are changing the landscape. “The system formation work that's going on is supporting the development of pediatric programs,” Grube said.

In suburban Chicago, Alexian Brothers Health System last year signed a letter of intent to form a pediatric partnership with Loyola University Health System. The alliance will allow both systems to share hard-to-find pediatric subspecialists and treat some of the patients who might have otherwise traveled downtown to Lurie Children's Hospital, which is affiliated with Northwestern University's Feinberg School of Medicine.

“I'm seeing that in every market,” said Raphe Schwartz, a director at the Chartis Group, an advisory firm. “Children's hospitals are facing increased competition from integrated delivery networks.”

As a result some children's hospitals, such as Lucile Packard Children's Hospital at Stanford, are moving to strengthen alliances with larger provider systems and developing regional expansion strategies. In addition, to fortify their position at a time when health plans are shifting to narrower networks of lower-cost providers, children's hospitals are backing a bill in Congress that would give states the option to establish nationally designated children's hospital networks operating across state lines to provide coordinated care for medically complex children.

Some observers worry that too many pediatric programs in a local market could create problems for all competing hospitals. They must not only vie for pediatric patients, but also for the limited pool of physicians with advanced pediatric training. “Pediatric specialist talent can get diluted and leave the market,” Schwartz said. “Premier children's hospitals need about 500,000 kids to really support pre-eminent programs.”

Centennial did not respond to a request for comment. But Monroe Carell Jr. Children's Hospital at Vanderbilt is seeing its best year of the past five, CEO Luke Gregory said. The children's hospital does not break out financials from the Vanderbilt health system.

“We still continue to grow market share,” Gregory said. “We have very robust specialty programs here. We really feel like we are the comprehensive provider throughout Tennessee.”

Pediatric care represents about 9% to 10% of healthcare spending, but offering a comprehensive set of services popular with young families allows systems to compete more aggressively for broader contracts with health plans, Schwartz said. Newcomers in the space also are attracted by the higher rates paid to the field's highly complex specialties.

Indeed, children's hospitals last year enjoyed higher margins than the hospital sector as a group, according to data from Modern Healthcare's financial database. The nearly two dozen children's hospitals tracked by Modern Healthcare had an average operating margin of 8.5% in 2014 compared with 3.4% for the broader group of 380 systems, independent hospitals and specialty hospitals in the database.

But as the operating environment becomes more competitive and challenging, children's hospitals are beginning to feel the pinch. Their 8.5% average operating margin last year was down from 9.2% the previous year, according to Modern Healthcare's financial database.

The number of staffed beds at freestanding children's hospitals increased 9.6% between 2010 and 2014, perhaps due to a number of completed construction projects during that time period, according to the Children's Hospital Association. Occupancy rates, meanwhile, have declined, with the 2014 patient to bed ratio at 71.6%, down from 73.6% in 2010.

Many of the newcomers are concentrating on a smaller scope of services that are often procedure-based, said Mark Wietecha, CEO of the Children's Hospital Association. “A lot of times when these bigger systems get into pediatrics, they're doing this off the base of a large obstetrics practice,” he said. “If you're in a good payment area, with 80% commercial, you can run a good business.”

Children's hospitals that pursue regional strategies are better positioned to fend off the new entrants. Monroe Carell has three off-site neonatal clinics, soon-to-be five after-hours clinics and 14 multispecialty medical clinics in the suburbs and exurbs that ring Nashville. This summer, it also opened a pediatric tower and emergency department at Williamson Medical Center in nearby Franklin, Tenn.

Lurie Children's Hospital of Chicago also has a regional expansion strategy. It plans to open an ambulatory-care center in the northern suburb of Northbrook in September. It also provides specialty services at two other suburban hospitals, Silver Cross Hospital in New Lenox as well as Northwest Community Hospital in Arlington Heights.

It is confident it can maintain its market position as merging systems expand their pediatric service line. “Our number of transports continues to increase year over year from centers we'd describe as our competitors,” CEO Patrick Magoon said. “There are services we provide that others do not.”

Premier children's hospitals still have the edge over newcomers in higher-acuity care, Kaufman Hall's Grube said. “Even in situations where you do have regional systems developing children's hospitals, they're often not quite at the same level in offering the super-specialized services” such as caring for children with rare cancers or severe heart conditions, he said.

The average daily census at freestanding children's hospitals increased 5% between 2010 and 2014, suggesting that children's hospitals are seeing patients with more complicated conditions, requiring longer inpatient stays.

But that doesn't mean children's hospitals aren't facing pressure. The higher prices they've typically commanded are under scrutiny as the entire healthcare industry transitions to insurers' narrow provider networks and capitated payment models. Seattle Children's Hospital found itself on the sidelines in 2013 after being left out of a number of plans being offered on Washington's health insurance exchange. The hospital sued and ultimately reached a settlement with the insurers.

“Even very well-respected children's hospitals are concerned that they're not going to be a must-have organization because of all the focus on rates,” Grube said. “They're trying to maintain a level of essentiality in the market.”

Most dedicated children's hospitals are the sole regional providers for highly specialized services such as cardiac surgery and transplants, and they offer more than six times the number of services as general hospitals, according to the Children's Hospital Association. “There is no redundancy,” Wietecha said. “And it's not something most consumers understand until they need it.”

Free-standing children's hospitals are facing the greatest challenges, Schwartz noted. “It's really impossible for children's hospitals to take accountability for an entire population,” he said. “They really have a strategic imperative to partner with the integrated delivery network.”

Lurie had a strong 2014, when it reported a net operating surplus of $37.5 million, up from $5 million the previous year. Its operating margin increased to 7.4% from 3.9%. But the results are leveling off, and Lurie is operating under the assumption that it will continue to face pressure on pricing, including from Medicaid, its primary payer, as well as pressure to move more care from inpatient to outpatient. “We're looking at just minor improvement in 2016,” Lurie CEO Magoon said.

The hospital has committed to cutting $150 million from its operating budget. About $40 million was cut in fiscal 2014, with another $17 million this fiscal year, which ends Aug. 31. It plans to cut another $23 million from its 2016 budget. Reducing its cost structure will help Lurie compete on price. The hospital expects some of those savings will come from care-coordination initiatives focused on efficiency. Lurie also began entering into value-based contracts through Illinois' new Medicaid managed-care program. Over the past six to eight months, it has signed similar agreements with several commercial insurers.

One advantage children's hospitals have is that the shift by most state Medicaid programs to reliance on private managed-care plans has given them more experience than general hospitals have with shared financial risk models. Medicaid represents from 40% to 70% of a children's hospital payer mix, Schwartz said.

The Children's Hospital Association is backing the bipartisan Advancing Care for Exceptional Kids Act, introduced in both the House and the Senate, which seeks to increase coordination among state Medicaid programs by facilitating data- sharing and reducing hiccups in care when a patient travels across state lines. It also seeks to raise the bar on quality. The fragmented state-by-state system prevents national data from being collected and quality standards from being set, the bill's supporters say.

Quality of care is where children's hospitals see their greatest strength, even as much of the market's attention has shifted to price. Many children's hospitals see using their quality credentials to pursue partnerships with larger health systems that would forestall head-to-head competition.

Northern California's Bay Area, for instance, is home to a number of large integrated-delivery networks, including Kaiser Permanente. But Lucile Packard Children's Hospital at Stanford sees its role as complementary to those bigger systems, especially given the challenge of recruiting pediatric subspecialists. “We classically are not a general pediatric provider, we're a specialist provider,” said Kim Roberts, CEO of Packard Children's Health Alliance. “As large as Kaiser is, they don't offer every service. We very much have taken a partnership philosophy.”

Packard Children's has eight partnerships around the Bay area and is exploring other alliances in California and other states. One example is its 2012 joint venture with John Muir Health system, which expanded pediatric specialty services in the East Bay. The partners recently opened a pediatric intensive-care unit in April in Walnut Creek.

Pediatrics is often lower on the list of areas where general acute-care hospitals invest, Roberts noted. “Most people are worried about aging baby boomers,” she said. “What we're finding is that others are turning to organizations like ours. By doing only kids, we have a breadth and depth of specialties.”