Geographic reach // Stability in the face of federal change // Risk diversification // Can they do it better, together?
Hospitals: The Merger Push
ILLUSTRATION BY VAULT 49
In 1878 the Sisters of Providence opened its first Seattle hospital, with Mother Joseph, known as “the Builder,” designing and supervising construction of the three-story brick building. Thirty years later, Nils Johanson, a surgeon and Swedish immigrant, persuaded 10 of his fellow Swedish-Americans to buy $1,000 bonds so that he could open Swedish Hospital, a 24-bed facility in a former Seattle apartment house. Then for much of the next century, the hospital systems that grew from those modest beginnings competed against each other. Swedish Health Services was smaller but highly regarded, with five hospitals and 100 primary care and specialty clinics. The regional powerhouse Providence Health & Services had 27 hospitals and other facilities stretching over five states.
In 2011, however, with the economy slack, medical costs rising, and insurance companies and the government reducing reimbursement, both health systems were feeling the strain. Amid revenue shortfalls and job cuts—and with the reforms of the U.S. Affordable Care Act looming—the two historic rivals announced they would join forces. “Both hospital systems saw the need to have a larger geographic spread to serve our communities,” says Arnold Schaffer, chief executive of Providence’s new Western Washington division, which includes all Swedish operations. And while it remains uncertain exactly how the federal law, also known as Obamacare, will affect hospitals, it mandates a reduction of $155 billion in U.S. payments for hospital services through 2019. “We’re assuming we’re going to get paid less,” Schaffer says.
For similar reasons, hospitals around the country are consolidating at a rapid pace, not just in their local markets but also across state lines. During the first nine months of 2012, at least 58 hospitals were involved in hospital mergers or acquisitions, according to Irving Levin Associates of Norwalk, Conn., which tracks health care transactions. Joint ventures, clinical affiliations and other types of transactions that stop short of full mergers have also become commonplace. “Everyone is talking to everyone, because size matters now,” says Lisa Goldstein, an associate managing director who follows nonprofit hospitals for Moody’s Investors Service. “We expect to see an active consolidation trend during the next two years.”
This isn’t only a matter of hospitals buying each other, Goldstein notes—they’re also being approached by health insurance companies and private equity firms that in many cases are taking ownership stakes. Hospitals are also purchasing nursing homes and physician groups. But it’s deals among hospitals that are really changing the landscape. “Organizations are collectively reorganizing themselves to meet a changing business model for service,” says James Blake, managing director of Kaufman, Hall & Associates, a consulting firm in Chicago. Hospital systems are preparing for federal changes that will bundle payments for hospital and physician services and emphasize quality of care. “Hospitals may be operating just fine in the fee-for-service world, but there’s a new world coming,” he says.
Yet there’s no guarantee that the latest wave of mergers will achieve the desired results. Integrating distinctly different cultures and operations can pose major issues, and projected financial benefits may not materialize. Meanwhile, research suggests that bigger isn’t always better: Past consolidations have led to price increases for hospital services that are passed along to consumers. But there’s reason for cautious optimism: In this financially strained landscape, size can have its benefits, such as a greater range of patient services and the promise of better coordinated care, as well as more bargaining power with insurers—which at least has the potential to drive down supply costs.
The federal Hill-Burton Act, passed in 1946, revived public spending on health care after years of neglect during the Depression and the Second World War. One goal was to put a community hospital in every county, and the resulting boom in construction achieved that objective in about 1,200 counties that had never before had a hospital. The law also guaranteed hospital care to citizens who couldn’t pay. During the 30 years that Hill-Burton was in effect, hospitals established themselves as corporate entities with established credit ratings that could fund their own growth by issuing bonds. Meanwhile, the introduction of Medicare in 1965 cast the U.S. government as a primary revenue source for hospitals.
During the 1970s, rising financial pressures on hospitals—and rapidly escalating federal costs—led to legislation supporting an alternative model for health care. Health maintenance organizations attempted to control expenditures by enrolling people in health plans that restricted which hospitals and physicians they could choose. And though that earliest incarnation of “managed care” ultimately failed to catch on in much of the country, it led to an era of deregulation in which hospitals were no longer shielded from competition.
At the same time, technological advances meant that many procedures that had been performed in hospitals could be moved to outpatient settings. And by the 1990s, with revenue growth slowing for many hospitals, a spate of consolidation began. The number of U.S. community hospitals declined from more than 7,000 in 1970 to barely 5,000 in 1999—a number that has fallen only slightly since then, according to the American Hospital Association.
Yet now business deals involving hospitals seem to be on the rise again, both because of the flagging economy and in anticipation of Obamacare. As costs are scrutinized and reimbursement drops, larger systems will be able to spread costs and risks over a broader patient population, and it will be easier for them to tap capital markets for funds to develop the organizational and information technology systems needed to show that they’re providing effective care, says Goldstein.
In a review of nonprofit hospitals published in 2011, Moody’s found revenue growth of 5.3% that year, an improvement over the 4.2% growth rate in 2010 but very slow by past standards. The AHA reports that more than a quarter of all hospitals ran deficits on their operations in 2010. Hospitals face flat to negative growth in revenue from federal and state governments via Medicare and Medicaid, which together provide more than half of hospital income.