Mergers, Acquisitions, Affiliations, and More

Transcription

1 The Camden Quarterly Volume XVI Number Mergers, Acquisitions, Affiliations, and More In this issue: Remaining Independent or Not: 10 Considerations for Hospital Board Members Merging for Financial Results in a Fee-for-Value World

2 Remaining Independent or Not: 10 Considerations for Hospital Board Members By Jonathan Spees, CPA With recent and potentially significant changes in the ways hospitals are reimbursed for services by both Medicare and commercial insurers, the boards of virtually every independent hospital in the nation are considering whether they can remain independent in the evolving new world. For many, this will be the most significant (and possibly irreversible) decision they will be asked to make as board members. As boards grapple with this important issue, the following are ten key considerations to bear in mind: 1 Defensible market share. The ability to prosper long-term depends significantly on the extent to which an independent hospital s market share is protected, either by geography (as in the case of sole community providers), market strength, or a durable competitive advantage. Expect the following hospitals to find it difficult to remain independent in the new economic and competitive landscape: Hospitals in concentrated markets with highly competitive service areas Hospitals in markets where powerful systems and alignments are developing Those with a high degree of loosely affiliated, split medical staffs Those whose reputation for quality and efficiency is lacking 2 Available capital. Access to capital is often a primary driver behind hospital consolidations. Hospital boards must evaluate their future capital needs from the perspective of the hospital s ability to generate funding on its own (either through internally generated funds, external borrowings, or equity placements). If expected capital needs exceed the board s realistic assessment of the current and future availability of independently generated capital, partnership with a larger organization possessing greater financial resources is necessary to assure long-term survival. Historically, a hospital s capital needs have centered on the age of its physical plant and its need for equipment upgrades or replacement. However, in today s environment, significant investments in information technology ( IT ) are essential in order to meet government mandates, participate in new models of reimbursement, and support population health management. Capital investments in IT often also result in concomitant increases in operating expenses for maintenance and support of new systems which in turn can reduce operating profitability and cash flow available for capital. Additionally, support for physician recruitment and possibly employment can represent significant future need for capital outside of normal operating needs for many independent hospitals. 3 Medical staff alignment and availability. In order for hospitals to have a sustainable longterm business model, they must possess and retain a quality medical staff which fully supports the hospital. Boards must consider medical staff planning and development issues in assessing their ability to go it alone. Factors such as average age, number of primary care physicians, long-term availability of specialists, and the plan for physician recruitment and retention will ultimately determine if a hospital can survive on its own. If the organization does not have enough resources to address medical staff issues, affiliation with a larger system may represent the basis to assure that quality healthcare services will remain in its local communities over the longer term.

3 10 Considerations for Hospital Board Members cont. 4 Payer relationships and payer mix. The ability to consistently generate a positive operating margin is necessary to fund capital or support external borrowing. Since payments from Medicare and Medicaid programs have often resulted in significant levels of unfunded care, hospitals historically have relied on cross subsidization from commercial and managed care payers in order to make up for losses on government patients. Most people believe that this cross subsidization will diminish as pressure from employers and individuals to lower healthcare costs increases. However, for most hospitals, having a favorable payer mix and maintaining a premium in commercial rates over Medicare reimbursement will likely continue to be critically important in order to generate sufficient earnings to support future capital needs (either borrowed or internally generated). Assessing the stickiness of a favorable payer mix and negotiating position with payers depends on a number of factors, including demographic trends in the service area and the importance of the hospital as a must have in the provider networks of current and evolving narrow network benefit plans. 5 Cost structure. Many independent and other hospitals are facing increasing pressure on their top line as increases in commercial rates are insufficient to offset inadequate or nonexistent increases in government reimbursements. For the first time in decades, evidence across the U.S. suggests that major commercial insurance companies are renewing hospital contracts with limited increases, or in some cases actual decreases, in payment rates. No one believes that this trend is likely to mitigate in the foreseeable future. This reduction in revenue per case has been a major contributor in the accelerating pace of adoption by hospitals in Lean, Six Sigma, and other performance improvement techniques. Hospitals, by their nature, require significant departmental and administrative overhead to provide quality healthcare services and comply with regulatory requirements. As the pressure to reduce operating expenses continues, independent hospitals, without the benefits of economies of scale, or that lack a significant revenue base to spread overhead due to their size, may be unable to generate sufficient capital from operations to remain competitive and sustain quality operations over the long term. 6 Quality as a differentiator. Even with recent changes in the availability of comparative data, it remains difficult to reliably compare the quality of care hospitals provide. However, it is widely believed that increased transparency through public reporting of hospital quality data will both improve outcomes and reduce cost. As healthcare becomes more consumer driven (a trend which will accelerate as employers move to defined contribution healthcare plans as illustrated by recent changes by Sears and Darden restaurants), quality will become an increasingly important determinant of sustainability. This is a particularly challenging aspect for a board to objectively review since few hospitals believe they provide inadequate or poor quality care. A brutal facts review of quality, an assessment of the measures that are required to demonstrate quality on a competitive basis, and an evaluation of whether a hospital has the time and resources to rectify deficiency should play an important part in any board decision about independence. One of the key goals of any affiliation should be to gain access to greater experience, capabilities, and resources available to improve the quality of healthcare services provided by the hospital. 7 Community support. For hospitals wanting to remain independent, strong support from their community will be an essential factor in determining long-term viability. Community support can be reflected in several important areas, including willingness of community members to stay within the local service area and support local physician practices, direct support of hospital capital needs or service lines through philanthropy, and indirect hospital support through mill levies and other property taxes. Hospitals that can rely on a sustainable level of strong community support over a long-term planning horizon will be in the best position to remain independent. (continued on following page)

4 10 Considerations for Hospital Board Members cont. 8 Managing population health. Shrinking margins from hospital operations and the move to global payments may mean that providers will increasingly have to take (and manage) healthcare risk. The ability to profitably manage risk requires a differentiated skill set, investments in IT, and a higher degree of clinical integration across the full continuum of care than what currently exists in many independent hospitals. Underwriting expertise, medical management capability, subcontracting, and claims processing are required to succeed in a capitated or bundled payment risk environment. Boards must evaluate whether their hospital has the time, resources, and ability to attract the necessary management talent in order to effectively participate in population health management without the support of a larger organization. 9 Talent acquisition and retention. Depending on the size of the institution and market, the ability to recruit and retain the highly skilled managers (which will be essential for success) can be quite different. Independent hospitals, which may have limited resources to support professional development and sharing of best practices, may have a more difficult time than systems which have existing infrastructure to support training and supervision, and do not leave executives feeling like they are on an island, faced with coping and adapting alone in a rapidly changing industry. 10 Ability to absorb a financial hiccup. The decision whether to remain independent or not requires board members to view a long-term planning horizon. Today s healthcare environment is in the midst of unprecedented change as it transitions from an episodic management, fee-for-service reimbursement model to a health management, value- based reimbursement model. In this rapidly changing environment, it is difficult to predict with certainty what will be the financial impact and timing of changes which will likely occur in patients insurance coverage, payment rates, and in how new affiliations may change the future competitive landscape. Hospitals with little margin for error because they lack sufficient capital reserves (or a strong financial partner) to provide resources for and provide a sufficient runway to adapt to unforeseen financial challenges are at significant risk of becoming unable to meet the healthcare needs of the communities they serve. While some boards may rightfully conclude that both maintaining independence and assuring their constituents have sustainable long-term access to high quality care at a reasonable cost can be achieved in their community, many hospitals seeking to define their future role will determine that bigger is indeed better and will affiliate with larger systems or other hospitals. The decision to affiliate, however, is only the first step in a process which must be carefully conceived and managed. A successful affiliation must secure the strongest possible commitments from a strategic partner pertaining to critical community needs such as community input in governance, maintenance and expansion of clinical services, preservation of employment for the hospital s employees, commitment to providing uncompensated care, and the amount, and the timing and allocation of future capital funding. For more information about how best to navigate through the process of affiliation, please contact Jonathan Spees at x3984 or jspees@ thecamdengroup.com. The Camden Group Continues to Grow In addition to welcoming Jonathan Spees, CPA as Senior Vice President, we are pleased to announce that Adam Medlin, MHA has also joined the firm as Senior Manager. With more than 30 years of experience in healthcare, Mr. Spees specializes in healthcare transactions, including mergers, affiliations, and acquisitions; corporate finance; and investment banking. Mr. Medlin specializes in valuations, financial assessment and modeling in support of value-based payments, including managed care contracting and reporting, risk pool reconciliation, payer contracts, financial forecasting, and hospital decision support.

5 Merging for Financial Results: Considerations in a Fee-for-Value World By Greg Shufelt, MBA, and Michael Miyagi, MBA, ASA Merger activity within the healthcare provider industry has been on the rise since the passage of the Affordable Care Act. New transactions among health systems, hospitals, physician groups, long-term care providers, and health plans seem to be announced daily. Given these trends and the continued pressures of healthcare reform and economic realities, executives and board members cannot afford to sit on the sidelines as their competitors consolidate and align around them. In order to find the right partner and maximize the financial benefits of an affiliation or merger, preparation and extensive due diligence from finance leadership is critical. Finance executives need to fully understand their organization s current capabilities and limitations, particularly as it relates to preparing for and pursuing value-based payment models, and how these strengths and weaknesses can positively or negatively impact the bottom line in an environment that is moving away from fee-for-service. Criteria to consider when assessing the financial impact of a transaction include both direct and indirect factors. Direct factors that can have an immediate financial impact include better access to capital, improved payer contracting, enhanced IT capabilities, and tighter and broader physician alignment. Indirect factors that may not have immediate benefits include taking steps to build the infrastructure and processes that will be required in a fee-for-value world. The following takes a closer look at some of these considerations. Direct Factors Enhanced access to capital is often cited as one of the primary drivers in mergers and affiliations. The financial burden associated with building the necessary infrastructure to support clinical integration and value-based payment models can be overwhelming for many standalone hospitals. Joining Millions a larger system, which often has better (and more favorable) access to funding via traditional capital markets due to stronger credit ratings, can provide the resources needed to fund delivery system transition. Beyond just having a more favorable credit rating, parties considering a transaction should assess the projected coverage ratios and debt capacity of the combined entities, as well as the internal strategic and capital commitments already in place. An enhanced credit rating may not always translate to available investment capital. In addition, non-traditional capital sources have returned to investing in healthcare services and technology, driven by the compelling demographic trends presented by baby boomers and the expectation of continued governmental support. The table below shows recent investment activity by private equity groups. Private Equity Investment in Healthcare 700 $ $ $ $60 $106 $94.4 $ $ $20 $ $ $ Source: Pitchbook A second consideration that can drive immediate financial results is improved and expanded payer contracts. Larger systems often have better payer contract rates and terms or contracts that the seller is not able to obtain on their own. Improved payment (continued on following page) Number of Deals

6 (continued from previous page) rates and expanded networks can have a significant and immediate impact on financial performance. An expanded and more robust IT infrastructure is a third factor that can have an immediate impact on financial performance. The right partner and IT strategy will also better position the selling organization for the future. In considering a transaction, each party should assess its existing IT infrastructures and capabilities (e.g., electronic medical records, meaningful use readiness, patient registries, data warehouse) and determine how combining or upgrading systems can mitigate or fill existing gaps. From a cost perspective, enhancing and expanding IT systems will likely be the single largest investment many providers will face as they prepare for value-based payment. Another consideration when assessing the financial impact of a transaction is physician alignment. Has the potential partner taken steps to expand its employed physician base and solidify its relationships with independent physician groups? Have they invested in facilities, equipment, and staffing (e.g., surgery suites, robotics/technology, clinical specialists, etc.) that will help attract new physicians and keep current physicians committed? Is the potential partner pursuing initiatives (e.g., bundled payments, comanagement arrangements, clinical integration, etc.) that will incentivize physicians to move away from a fee-for-service, volume driven mindset? By evaluating the criteria listed above, each party can assess the expected financial impact of pursuing a merger or affiliation and determine if the acquired organization can contribute to the bottom line within a combined system. Other considerations that should be analyzed include overhead allocations and other expenses that will be incurred as a result of the partnership, and potential cost savings and other synergies that could materialize via the consolidation of services and programs. Indirect Factors In addition to considerations that have an immediate impact on financial performance, organizations considering a transaction should also look long-term and assess future financial implications and risks. What would an expanded and enhanced care network mean in an environment where payments are based on population health and reduced cost of care? Being prepared for accountable care means taking steps now to establish the necessary infrastructure and building blocks, even if that means incurring short-term losses while straddling the fee-for-service world. Partnering organizations that complement one another in regards to establishing an accountable care infrastructure can expedite their transition and readiness to effectively and successfully manage population health. Finding the right partner is not easy, and the evaluation process needs to be about more than just acquiring an asset at a good price. Transactions need to be about enabling the evolution to value-based care and positioning an organization for financial success in an environment that rewards keeping a population healthy over treating the sick. For more information on financial considerations to transactions, please contact Greg Shufelt at or gshufelt@thecamdengroup.com or Michael Miyagi at or mmiyagi@ thecamdengroup.com. Look for... The Camden Group s Top 10 Trends in 2013 in a special edition of The Camden Quarterly to be published in January 2013! Each year we predict the major trends and their implications for the healthcare industry. With 2014 looming ahead, you will not want to miss this critical issue of our newsletter! If you would like to receive this newsletter by , have comments or questions, or need to make address corrections, please contact Sarita Choy at or schoy@thecamdengroup.com. The Camden Quarterly is published four times annually by The Camden Group, Los Angeles, CA. Editor Sarita Choy. Copyright 2012 The Camden Group. All rights reserved.