For-profit hospitals blaze separate path to efficiency, quality

After the first for-profit hospital chain began operating in Nashville in the late 1960s, not-for-profit hospital leaders feared companies such as Hospital Corporation of America and other for-profit upstarts were coming to take over their world.

Today, those fears are a distant memory.

Fifty years after establishing the Federation of American Hospitals to represent their interests in Washington, for-profit hospitals have established a large and stable market niche, with dominant positions in certain Sunbelt markets. They have moved past fraud scandals and most criticisms about their business practices to gain broad respect for their ability to operate hospitals efficiently while achieving solid performance on quality and safety.

On the flip side, federation leaders no longer have to spend their time justifying the existence of for-profit hospitals, as the federation's first Washington-based leader, Mike Bromberg, had to do. “We were a pariah to a lot of liberals who wanted to ban them,” said Bromberg, who served as the association's CEO from 1969 to 1994 and remains vice chair of the board. “Now we've sort of proved ourselves, and it's recognized that for-profit hospitals give consumers choices.”

Some analysts say the for-profits have even helped their not-for-profit competitors by forcing them to tighten their management practices and up their game. “The firms you see today are actually held to somewhat higher standards than their not-for-profit competitors in their economic dealings with physicians, because of the past regulatory scrutiny,” said Jeff Goldsmith, a national adviser to Navigant Healthcare and associate professor of public health sciences at the University of Virginia.

In some markets, the lines between the two hospital sectors are blurring as for-profit and not-for-profit systems join forces to run hospitals in states including Alabama, Arizona, Virginia and Texas. “We think the opportunity of creating partnership ecosystems (with not-for-profits) is a better form of growth than going out and buying hospitals,” said Trevor Fetter, chairman and CEO of Tenet Healthcare Corp., which owns four Dallas-area hospitals in partnership with Baylor Scott & White Health as part of its stable of 84 hospitals.

“We have a lot of experience working with nonprofit providers and we think our track record is strong,” said Milton Johnson, chairman and CEO of HCA, which has 168 hospitals and 237 outpatient-care facilities in 20 states.

Meanwhile, the federation has become a close and powerful collaborator with the American Hospital Association and other not-for-profit hospital associations on policy advocacy, including pushing for healthcare reform and coverage expansion in 2009. “On most payment, coverage, accountability and quality issues, a hospital is a hospital and we're all coming from the same place,” said Chip Kahn, the federation's CEO since 2001. “We supplement each other very well. One of our advantages is we can be very focused on a few key issues that affect our members the most.”

But the dynamics that drove the rapid growth of the investor-owned chains from the 1960s through the 1990s have changed dramatically, dimming the odds of another big expansion spurt. When they started out, these companies used equity capital and took advantage of the new Medicare program to build and expand hospitals in Sunbelt states with burgeoning populations and a dearth of major not-for-profit facilities.

In an environment of rapidly growing healthcare expenditures by government and private payers, they had the cash flow to buy up for-profit, physician-owned hospitals that were poorly managed and use their superior management skills to improve performance and boost returns for shareholders.

Now, however, the dynamic has changed. Payers are squeezing rates. Most Sunbelt markets where the for-profits are concentrated are saturated. And patients and payers increasingly want care provided in lower-cost outpatient settings. Many investors no longer see hospitals as a good growth bet.

“The entire hospital sector is laboring under the worst pricing environment we've ever seen for hospital services,” Goldsmith said. “Venture capital and private equity firms won't put up the capital because this business has seen very significant changes in operating requirements and reductions in potential return on capital over the last five years.”

That challenging operating environment is at least part of the reason for-profit hospital CEOs support continuation of the Affordable Care Act's coverage expansions after the November elections. “I certainly don't think Obamacare is going away, nor would I want it to,” said Alan Miller, chairman and CEO of Universal Health Services. “It has expanded coverage to, if you believe the numbers, around 20 million people. That's a good thing for them, and it's good for us, too.”

“We hope that after the election is over and the politicizing of the uninsured can be reduced, more people can be insured through expansion of Medicaid in many more states,” said William Carpenter, chairman and CEO of LifePoint Health.

For-profit hospitals' share of the U.S. hospital market has continued to edge up over the past decade, following the explosive growth of the 1980s and '90s. In 2014, 21.4% of community acute-care hospitals in the U.S. were investor-owned, accounting for 17.3% of inpatient beds, according to American Hospital Association data. That compares to 17% of community acute-care hospitals being investor-owned in 2004 and accounting for 14% of beds; and in 1994, they were 13.8% of all hospitals and accounted for 11.2% of beds.

While the for-profit sector's overall expansion has been more modest in recent years, that hardly means the five largest investor-owned chains—HCA, Tenet, Community Health Systems, LifePoint and Universal—haven't been aggressive in acquiring and building new facilities. They have focused on developing concentrated networks in selected markets, mostly across the Southern half of the U.S. but also in certain Midwest outposts. A major goal is to strengthen their bargaining power as health insurers consolidate.

“If you don't have substantial market share, the insurance companies don't need you,” said Miller, whose company operates 244 acute-care hospitals and behavioral health facilities in 37 states and the United Kingdom. “They will just say, 'Here are the rates and if you like them, fine, if not, thank you very much,' and they'll move on. But they can't do that with us because we have become very important in every market we're in.”

The CEOs of the five companies and other industry experts say no one should expect buying binges or major mergers in the next few years, though there may be smaller mergers like the recent $550 million deal between RegionalCare Hospital Partners and Capella Healthcare. The last big tie-up of for-profit hospital chains came in 2014 when Community Health Systems acquired Health Management Associates, which led to severe integration problems for CHS. The year before, Tenet completed its acquisition of Vanguard Health Systems, which saddled Tenet with a lot of debt.

It's far more likely that the five chains will continue to make strategic acquisitions and expansions, including adding outpatient centers and free-standing emergency rooms, to draw more patients into their system and boost their bargaining clout with insurers. They all recognize that a large and growing percentage of their revenue now comes from outpatient services.

“You won't see any of these (companies) try to build new footprints in new markets,” said Brian Tanquilut, a senior healthcare equity analyst at Jefferies & Co. “They realize they need to be deeper rather than wider.”

The five companies have diverged sharply in their recent financial performance, and their growth strategies differ significantly. All are struggling with substantial levels of uncompensated care, particularly in states that have not expanded Medicaid to low-income adults. For instance, HCA's same-facility admissions of uninsured patients rose more than 11% in non-expansion states, particularly Florida and Texas, in the first quarter of 2016 while remaining flat in expansion states.

Nashville-based HCA, which has built strength in urban markets, mostly in the South, has seen higher earnings and strong share prices through the first quarter of this year and has enjoyed above-average volume growth. It's investing heavily in free-standing ERs and urgent-care centers, higher-acuity service lines such as trauma and burn care, and physician practices. HCA “is ahead of the curve in strategic thinking and positioning, investing back in the business and doing opportunistic deals,” Tanquilut said.

Dallas-based Tenet also operates primarily in urban markets and has invested heavily in outpatient surgery and revenue cycle and other services through its Conifer subsidiary. It saw its stock price battered in recent months, though, because of high debt and costs associated with a whistle-blower lawsuit. But its 2015 acquisition of United Surgical Partners International has positioned the company well for the ongoing shift to outpatient care, Tanquilut said.

Franklin, Tenn.-based CHS has seen its earnings and share price slump as the predominantly rural communities it serves have suffered economically. And it has struggled to integrate hospitals acquired in its merger with Health Management Associates, particularly facilities in Florida. Community just spun off 38 small and rural hospitals into the newly independent Quorum Health Corp., and it plans to divest at least 14 more hospitals, using the proceeds to pay down debt.

Wayne Smith, Community's chairman and CEO, said his company plans to drop from about 160 hospitals in 22 states to 140 or 150. “We'll focus our resources and capital on hospitals with strong margins in sustainable markets and add more complex services in those markets,” he said.

Brentwood, Tenn.-based LifePoint also has faced a tough economic environment in its largely rural markets. But it has less debt than CHS and has continued to acquire facilities, sometimes in partnership with not-for-profit systems including Duke University Health System and Norton Healthcare. LifePoint has done a “really, really good job” of buying ailing community hospitals in rural markets and turning them around by improving operations, said Joshua Raskin, managing director of Barclays Capital's healthcare sector practice.

“We're trying to cover the continuum of care in communities where we operate and work in partnership with a tertiary provider such as Duke to ensure we are providing care in the most appropriate setting that can be done safely and efficiently,” Carpenter said.

King of Prussia, Pa.-based Universal has done well financially with its strong focus on behavioral healthcare, boosted by its 2013 purchase of Psychiatric Solutions, which doubled its number of psychiatric hospitals to nearly 200. One cloud is that more than two dozen of its facilities are under federal investigation in connection with possible false claims, the company recently reported.

CEO Miller said the nation's growing recognition of the need to expand and improve behavioral health and substance-abuse treatment will help his company. “There are great stresses in our society, and I think sometimes drugs and alcohol are a reaction to that,” he said. “Families used to hide mental illness. Now we realize that mental ailments are a sickness like physical ailments that can be treated, and there's nothing to be ashamed of.”

While all five companies are focusing on expanding their volume of high-acuity services, there are questions about whether they are preparing adequately for the shift to new value-based payment models such as accountable care organizations and bundled-payment arrangements, which reward outcomes rather than volume. Tenet has been the most active in alternative payment models, with its hospitals participating in 17 ACOs serving 800,000 covered lives. Its Detroit Medical Center has been a leader in the Medicare Pioneer program.

Several CEOs expressed reservations about the viability of these initiatives. “Value-based reimbursement is financing, not provision of healthcare,” HCA's Johnson said. “The first thing we have to do is drive more value through better patient safety and outcomes.”

“LifePoint is carefully considering all the various new and potentially innovative payment models out there, and we as a non-urban provider are probably in a little better position to watch and learn from the mistakes of others,” Carpenter said. “We aren't rushing to create ACOs in every market.”

“We're easing into it,” said CHS' Smith, whose hospitals are participating in 11 bundled-payment pilots. “It's a slow process, and it's not going as quickly as you might think.”

Outside observers say it's not surprising the investor-owned chains are moving cautiously because they have prospered in the fee-for-service environment and there's no certainty the current value-based models will prove profitable. “These companies have spent decades building leading market share in their top markets, and now there's the potential for disruption,” Raskin said. “The world is shifting and it's creating unease among them.”

But Gerard Anderson, a professor of health policy and management at Johns Hopkins University, warned that the for-profit systems may face a steep learning curve if they continue to largely sit out these value-based payment experiments. “The challenge for the investor-owned companies is demonstrating value in the new environment,” he said. “They've been very successful in promoting volume. I'm not confident they can make that pivot.”

Tanquilut said investors will be watching to see which of the companies have leaders they trust to adapt to the changing payment and delivery models. “At some point we will be shifting, and you want to make sure you're behind a company that will know how to thrive in those models,” he said.

There also are lingering concerns about the investor-owned chains' pricing practices and sharp focus on financial returns—and how that may affect the communities they serve. A recent Health Affairs study co-authored by Anderson found that for-profit hospitals generally had higher surpluses per adjusted discharge than other types of hospitals and that the large majority of hospitals with high charge-to-cost ratios and high profitability were for-profit facilities.

“When you compare similar for-profits and not-for-profits, the for-profits are much more likely to invest in profitable services and are quicker to follow the money when profitability changes,” said Jill Horwitz, a UCLA law professor who has studied hospital practices by ownership type. “I'm quite worried about the role for-profit medicine plays even for well-insured patients.”

But others say the differences between the for-profit and not-for-profit sectors have essentially disappeared, if they ever existed. LifePoint's Carpenter stressed that his company's executives talk with Duke University Health System leaders almost daily to collaborate on quality of care and hospital management issues for the 14 hospitals in four states they operate under a joint venture. “They were impressed by our commitment to investing in improving quality of care, which exceeded their expectations,” he said.

Just like at the best not-for-profit hospitals, “our No. 1 priority is continuously looking for ways to improve patient safety, clinical outcomes and the patient experience,” said HCA's Johnson, noting his system's success in reducing infection and sepsis mortality rates. “We have a lot more in common than we have differences.”