Hospital Mergers and Acquisitions, Research Paper Example

Abstract

There have been significant organizational changes within the hospital industry during the course of the last 10 years. Mergers and the extensive consolidation of hospitals have formed numerous new hospital systems. Hospital systems nationwide are increasing, despite the fact that hospital system acquisitions are slowing down(Moody, 2011). For-profit and nonprofit hospitals have been active members in forming local concentrated systems. Researchers historically regarded system formation primarily as an issue that pertains to hospital ownership conversion. In other words, system formation was mostly seen as the expansion of national, for-profit systems(Luke, Luke, & Muller, 2011). As such, little attention has been placed on locally concentrated systems and its impact on competition and patient care. In reality, both nonprofit and for-profit hospitals are active in the materialization of locally concentrated systems. However, the effect of such practices on consumers remains unknown. It remains unclear what impact the formation of hospital systems have on consumers. In other words, it remains unclear if dispersed hospitals or locally concentrated systems have a better or worse effect on consumers (Luke, Luke, & Muller, 2011). Recent research indicates that locally concentrated systems have an adverse effect on policies. The research indicates that locally concentrated systems are directly linked to rising hospital prices; thereby resulting in anti-competitive behavior. In order to better understand the pros and cons involved in hospital consolidation, it is important to understand the nature of system formation (Robinson & Dratler, 2006).

Introduction

There have been significant changes in the organization of the hospital industry over the past 10 years. One such change refers to the broad consolidation of hospitals. Hospital systems and mergers are key components of any hospital consolidation. Historically, most research that pertains to hospital consolidations and mergers focused primarily on merger transactions. As such, very little attention has been placed on system acquisitions. In order to understand the full effect of hospital acquisitions, one must address hospital systems and its subsequent effect on healthcare markets, as well as on consumers.

Both mergers and acquisitions play key roles in the process of hospital consolidation. Mergers are defined as transactions where independent hospitals join forces to operate under a shared license(Luke, Luke, & Muller, 2011). Most often, this occurs between hospitals that are located within close proximity of one another.  Acquisitions are defined as the process where different hospitals merge, but operate under their own licenses. These hospitals are owned by a shared governing body, and do not have to be within close proximity of one another(Wright & Perry, 2010).

Current knowledge about hospital consolidation is based on prior studies of hospital mergers. It is important to note that acquisitions and mergers reveal unique hospital strategies. As such, each strategy presents diverse results on efficiency. Geographic locations of the involved hospitals also have a profound impact on the mergers’ and acquisitions’ market power, as well as on the varying health plans that each facility can provide (Moody, 2011). The formations of hospital systems are dependent on the answer to various questions. For instance, policymakers may inquire if the nature of a hospital will be altered if it joins a system; if patient safety, costs, quality of care, and prices are compromised if a hospital joins a certain system; and if the operational efficiency of hospitals is dependent on the system’s geographical location.  Findings

It remains unclear what impact the formation of hospital systems have on consumers. In other words, it remains unclear if dispersed hospitals or locally concentrated systems have a better or worse effect on consumers (Luke, Luke, & Muller, 2011). Recent research indicates that locally concentrated systems have an adverse effect on policies. The research indicates that locally concentrated systems are directly linked to rising hospital prices; thereby resulting in anti-competitive behavior. In order to better understand the pros and cons involved in hospital consolidation, it is important to understand the nature of system formation (Robinson & Dratler, 2006).

Trends in Hospital Consolidation

Hospital mergers in America peaked in 1996 when the industry saw 152 mergers. Within four years that numbers declined significantly and 2000 saw only 18 mergers. During that same period there were far more hospital consolidations from acquisitions than mergers alone. In fact, in 1997 there were a total of 310 combined mergers and acquisitions. That number remained comparatively high until 2000 when there were 132 combined mergers and acquisitions (Moody, 2011).

It is a common misconception that national hospital chains are large systems that account for the majority of national inpatient admissions. In fact, many of these large systems operate similarly to smaller chains or independent hospitals. For instance, in 2005, HCA-The Healthcare Company (the nation’s largest system) accounted for only six percent of all national inpatient admissions. The benefits of these hospital systems are therefore not designed to address an extensive population, but rather a local market. Research indicates that these systems, specifically those who are geographically centralized, deliver improved services and coordinated care. As such, the effectiveness of a hospital system is not dependent on its size, but rather on how it can affect local markets (Robinson & Dratler, 2006).

The number of hospitals that have not joined a system have shown a steady decline since 1995. Solo hospitals are most often private for-profit or nonprofit hospitals. Historically, government-owned hospitals have been more prone to join systems than private hospitals. However, that pattern changed over the course of the last decade (Nathan, 2005). More privately-owned hospitals have joined hospital systems because they find that their combined efforts and expertise is of more use to the general public than their sole operations. Also, more privately-owned hospitals have joined forces with other privately-owned hospitals that are located in the same metropolitan statistical area (MSA). In fact, in 2005 at least 33 percent of all private hospitals were partnered with at least one other hospital in the same MSA; that number continues to rise (Robinson & Dratler, 2006). Hospitals are considered to be in a local system if they are partnered with at least one other hospital in the same MSA. In other words, even if a system consists of five hospitals, it will still be considered a local system if two of the five hospitals are in the same MSA.

Local systems accounted for large number of total patient admissions over the course of the last decade. In fact, these local systems accounted for nearly 50 percent of total inpatient admissions in 2000 (Robinson, Consolidation And The Transformation Of Competition In Health Insurance, 2004).

Local Systems

As mentioned before, hospitals within local systems were predominantly private for-profit and nonprofit hospitals. Public hospitals have been lethargic in joining this growing trend. Their efforts to join local systems have been outdone by the growing number of for-profit and nonprofit hospitals (Wright & Perry, 2010). The majority of hospitals within local systems are nonprofit hospitals. In 2000 more than 40 percent of all hospitals within a local system were not-for-profit. Although the number of nonprofit hospitals within local systems continues to increase incrementally, the number of for-profit hospitals within local systems has remained steady over the course of 10 years (Robinson, Consolidation And The Transformation Of Competition In Health Insurance, 2004). Teaching hospitals have also become more involved in system participation. The number of teaching hospitals within local systems has doubled over the course of five years. It is more common for hospitals to join local systems if those hospitals are located in urban areas. Managed care is cited as a main reason that many hospitals join local systems. In fact, research indicates that hospitals with low managed care penetration were less likely to join local systems than hospitals with high managed care penetration. In other words, a group of hospitals with tighter managed care are more likely to join local systems than hospitals that lack that facet (Luke, Luke, & Muller, 2011).

Affordable Care Act

Healthcare reform within the U.S. plays a significant role in the consolidation and integration within the hospital industry. Since the implementation of healthcare reform, there has been a rise in the number of mergers between hospital systems (Moody, 2011). Additionally, there has been a significant increase in the number of instances where physicians integrate their services with other providers. As mentioned before, hospital consolidations have increased within the last decade. Prior to the spike in mergers and consolidations the majority of transactions were prompted by external threats of managed care (Luke, Luke, & Muller, 2011). More recently transactions have been prompted by microeconomic issues that numerous smaller hospitals and larger systems faced. Most of these issues developed because smaller hospitals did not have sufficient resources to remain active and defend against competition. The American Hospital Association cited that the number of hospitals in America declined from 5,194 in 1995 to 5,008 in 2011; nearly a 3.5 percent decrease. However, the number of hospitals within systems has increased by nearly 400 hospitals between 1999 and 2009. There are currently an estimated 4,500 operational hospitals in the nation; 80 percent of them are operated by nonprofit and government organizations. The remaining 20 percent are operated by for-profit companies (Moody, 2011).

The healthcare industry comprises an estimated five percent of the nation’s gross domestic product and a staggering amount of independent hospitals represent a large amount of fragmentation. Each transaction currently involves one or two hospitals per transaction. This practice is indicative of a vastly disjointed industry. There are currently roughly 10 leading companies within the hospital industry; each one makes up an estimated one percent of the total market (Luke, Luke, & Muller, 2011). The result of the fact that nearly 80 percent of all hospitals are owned by nonprofit organizations is that those hospitals have less access to capital. Nonprofit organizations’ external capital is derived from the municipal bond market. For-profit companies use their equity to finance growth but nonprofits do not have that luxury (Moody, 2011).

Failure to consolidate rests on the local economy. Research indicates that consumer express preference in local oversight and increased access to healthcare resources (Robinson & Dratler, Corporate Structure And Capital Strategy At Catholic Healthcare West, 2006). Hospitals’ desire to remain tax-exempt often highlights this notion. Although the municipal bond market is partly responsible for the industry’s fragmentation, changes within the investor base may soon change this. Municipal securities are experiencing a shift from retail to institutional holders. As such, issuers are held to a higher standard. Additionally, local thinking thrives when decision making is based on politics rather than business. To date, market forces have not been strong enough to force hospital consolidations; however, decreased availability of funding through the bond market, and the looming healthcare reform will soon prompt an influx of hospital consolidations. The effects of healthcare reform on hospital consolidations include increasing costs, encouraging integration, and decreased revenues (Grogan & Patashnik, 2003).

Decreased Revenues

The primary goal of healthcare reform is an increase in preventative care so that patients will be less likely to visit the hospital due to improved health conditions (Greaney, 2002). However, such practice will decrease inpatient revenues. Another aspect of healthcare reform is that it will reduce payment rates, which will indirectly force hospitals to find unique ways to increase negotiations with suppliers and subsequently reduce overhead. This will ultimately force consolidations (Ho & Hamilton, 2000). One aspect of the Affordable Care Act is a value-based purchasing program. This program penalizes hospitals that do not meet quality measures; usually in the form of pay cuts, and rewards those that do. One result of this program is that it increases competition among hospitals by implementing pay cuts to those subpar performers (Luke, Luke, & Muller, 2011). This program proves more beneficial to larger organizations or systems because they have greater critical mass. Furthermore, larger systems have the ability to disperse fixed costs over a wider revenue base. This means that business units who perform better can compensate for those units that exhibit subpar performance. Furthermore, larger systems have easier access to better rates. Lastly, larger systems have improved capabilities to develop systems that can effectively measure quality (Moody, 2011).

Increasing Costs

Providers, such as hospitals, will incur increased costs as a direct result of healthcare reform. This is mainly true because compliance costs will increase. Under the healthcare reform stipulations, hospitals are required to publish a list of its charges and fees. Certain hospitals; specifically those defined as 501(c)(3) hospitals, must follow new debt-collection practices and must conduct a community health assessment every three years(Moody, 2011). As such, improved patient care will become dependent on improved medical practices and medical equipment; all of which will cost more money. Another requirement for improved clinical care will be the employment of more physicians. Lastly, size and credit ratings of smaller institutions have a profound impact on that institution’s ability to generate capital in order to adhere to healthcare reform requirements(Jaklevic, 2002).

Encouraging Integration

Another aspect of healthcare reform is the Accountable Care Organization (ACO) model, which primary goal is to reward clinical integration. This model is supported by the Medicare Shared Savings Program and designs a means for cost saving if a hospital achieved a certain level of quality measures. Such practice directly encourages integration (Luke, Luke, & Muller, 2011). For instance, one ACO model consists of a hospital, a specialty physician group, and a primary care physician group. As such, it promotes quality reporting and shared control. This model is most likely to be utilized by larger systems because they have higher levels of sophistication to develop and manage these models (Luke, Luke, & Muller, 2011).

Current Hospital Merger and Acquisition Market

Healthcare reform has prompted a large number of nonprofit organizations to expand. Before the reform, these organizations were not acquisition-minded. Despite being sophisticated organizations, nonprofits have had little experience in merger transactions. As such, various awkward approaches have stemmed from their previous merger transactions. Financial depravation is also no longer a key motivator for sellers (Wright & Perry, 2010). Over the past 10 years hospitals lost access to capital if they had good market share. However, increased needs for improved facilities prompted nonprofit organizations to enter into combination transactions. Things are different today. Nonprofit organizations and smaller hospitals no longer face the financial strains they once did, and therefore are no longer forced to enter into transformative transactions (Jaklevic, 2002).

Current transaction structures are typically cashless agreements between mergers. Previously these transactions were characterized by outright sales in the form of cash, between nonprofit and for-profit organizations. The preferred means of hospital acquisitions have changed over the past decade. For instance, larger nonprofit systems are more inclined to be proactive in their acquisition processes. One example is their likeliness to cross state lines for an acquisition; a practice that they would have been reluctant to do historically. Also, nonprofit organizations are more likely to invest in hospitals directly, instead of acquiring a hospital by funding a local hospital foundation. These direct investments give nonprofits an opportunity to make capital commitments that span over the course of several years (Moody, 2011). These types of acquisitions also make it more difficult for investor-owned buyers to compete. The result is that investor-owned buyers are forced to review outdated valuation procedures so they can justify premiums paid by larger nonprofit strategic buyers (Nathan, 2005).

Another strategy employed by investor-owned companies is the development of creative ways to make their proposals more attractive (Roney, 2012). One such example is the tremendous attention that LifePoint received from its relationship with Duke Medicine. This particular partnership is attractive because it offers the scale productivities of a for-profit buyer that is focused on expanding healthcare services at the acquired hospital, while concurrently delivering the quality infrastructure of a nonprofit partner. Such models are predicted to continue to gain reputation (Roney, 2012).

Many large cities with extensive impoverished populations cannot afford to lose hospitals. This fact has prompted a new trend within the industry, exemplified by two recent transactions in Michigan and Massachusetts. These communities have been historically antagonistic toward investor-owned buyers. However, I rising fear for the loss of more hospitals have resulted in the transactions that involve Detroit’s Van Guard Health Systems and Boston’s Cerberus Capital Management (Mattioli, 2012). These transactions indicate that the states are more accepting of for-profit companies because they have the ability to prevent closure. These transactions are examples of solutions for hospital systems and banks alike. In Detroit, Vanguard purchased Detroit Medical center; an eight-hospital nonprofit system, at the state’s approval. In Boston, Cerberus purchased Caritas Christi Health Care; the state’s largest hospital system. An accumulation of such transactions could potentially result in larger percentages of for-profit companies, which could subsequently alter the entire makeup of the healthcare industry (Mattioli, 2012).

Community Considerations

It is crucial for a hospital’s management to consider the impact that a sale or consolidation will have on the community. Most communities have an emotional reaction when a local hospital is sold; especially to an out-of-town investor. Most community issues occur when the community claims that they received inadequate notification of hospital sale. These public relations disasters could significantly impact the success of a transaction. Change of hospital ownership is an important issue that each community should be aware of. Research indicates that if a community feels that they have not been properly informed of a proposed sale that said sale could fail, costing buyers, and/or sellers, hundreds of millions of dollars (Luke, Luke, & Muller, 2011).

The board of directors is typically at the starting point of the communication process. It is their responsibility to fully understand all factors involved in driving a consolidation and all the circumstances that pertain to their specific hospital. Once the board is adequately educated on the process, it is their responsibility to communicate the process to physicians and employees, and then to community leaders and other stakeholders. Experts recommend that the board of directors should hire a public relations firm to communicate the process to the community (Robinson & Dratler, Corporate Structure And Capital Strategy At Catholic Healthcare West, 2006). Furthermore, transparency is a crucial aspect of the consolidation process. Although it is important to keep the identity of potential buyers completely confidential, all factors relating to the hospital should be transparent. Additionally, it is recommended that at least two well-respected physicians should serve on the negotiating committee, as they have a closer connection to the medical staff than other members of the board. It is also equally important that these physicians keep all negotiations private. Their purpose is to ensure that the needs and concerns of the hospital staff will be adequately addressed during the negotiation process. Another suggestion for successful community involvement is the fact that board members should inform community leaders and politicians about their plans, so that they do not feel caught off guard once the news finally breaks (Greaney, 2002).

Tax-Exempt Considerations

The majority of tax-exempt hospitals are under contracts which mandate that they serve their local communities. These hospitals employ various strategies to ensure that their local communities benefit from an acquisition or a merger. For instance, oftentimes it is possible for the board of directors to remain in place, even after a transaction, and even after they are subject to the powers of the acquiring entity (Jaklevic, 2002). Similarly, some transactions require that future board members of the new system reside within the local community. Another important factor to consider with tax-exempt hospitals is their continued commitment to charity. The majority of acquiring entities have no qualms with adhering to the hospital’s charity care policies. Additionally, most acquiring entities agree to preserve all employees, in addition to their medical staff privileges (Moody, 2011). Transactions are typically reviewed by state attorneys general and the aforementioned factors are important to them during these reviews.

Most affiliation agreements are underwritten with an agreement that the acquiring party will remain committed to maintain several core services, and that they invest resources to add additional services within a given timeframe. The seller is usually the only party who can agree to change these stipulations. It is therefore crucial for the seller to ensure that at least one entity remains in place that can enforce changes to this agreement. Such practice will most likely solidify a new organization (Greaney, 2002). The seller’s board of directors is usually the authoritative entity that can enforce or revoke such an agreement. In cases when the board is not the authoritative entity, the hospital will designate a specific person or organization to ensure the fulfillment of all contractual agreements.

These transactions’ considerations often stems from the sum of the assumption of liabilities, the purchase price, and a legally binding commitment to make capital disbursements. Assumption of liabilities refers to interest rate swaps, long-term debt, and pension liabilities (Luke, Luke, & Muller, 2011). In the past the seller’s board of directors negotiated for, two or all of these considerations. However, consolidators and sellers have struggled with the outcome of many of these transactions because the buyer typically would accrue the majority of the benefits and the local community would receive only partial benefits. Consequently, little attention was given to fair market value in the nonprofit hospital merger and acquisition market.

The board of directors has a fiduciary duty to the hospital and the community to ensure the longevity of the seller’s charitable purposes. The board therefore has to ensure that the hospital receives fair market value for signing over the facility to another organization (Nathan, 2005). It is thus the responsibility of the board to examine all strategic alternatives simultaneously and not successively. This has been proven to be the most feasible means for the board to maintain its fiduciary responsibilities.

Due Diligence

In the event of an acquisition or merger, the buyer is at a heightened risk of inheriting serious supervisory liabilities from the seller. Common business practice indicates that buyers are not keen on problems. The seller should therefore attempt to resolve any and all issues that could potentially ruin the sale. The seller should therefore adopt a proactive approach in order to ensure a smooth transaction (Wright & Perry, 2010). One such an approach is to ensure that the hospital’s survey history and results are in good standing. These factors include environmental surveys, Medicare, and accreditation. In the event that something out of the ordinary appears on the hospital’s record, it is the responsibility of the seller to resolve the issue. Another proactive approach is the assurance of a vigorous compliance plan. Such a plan administers regular monitoring of financial relationships and physician compensation to prevent potential fraud and abuse concerns (Moody, 2011). Additionally, it is the responsibility of the seller to ensure that no billing and payment issues are unresolved prior to the transaction. If the hospital is paid by a government program for the transaction, experts recommend a billing and coding audit. Any potential problems will be detected through an examination of coding and payment rules. Any shortcomings will therefore be detected through an audit (Mattioli, 2012).

Conclusion

There have been significant changes in the organization of the hospital industry over the past 10 years. One such change refers to the broad consolidation of hospitals. Hospital systems and mergers are key components of any hospital consolidation. Historically, most research that pertains to hospital consolidations and mergers focused primarily on merger transactions. As such, very little attention has been placed on system acquisitions. In order to understand the full effect of hospital acquisitions, one must address hospital systems and its subsequent effect on healthcare markets, as well as on consumers.

Recent federal healthcare reform has instigated an increase in consolidations within the healthcare industry. Historically, the hospital industry has been highly fragmented. Healthcare reform promises to modernize the industry to accommodate the increasing demands of consumers as well as the industry. The success of the reform depends largely on the actions of hospital boards, communities, and hospital leaders. These individuals are responsible for laying a solid foundation within the hospital industry that will remain stable in future decades. Internal and external finance leaders should be well acquainted of consolidation and merger trends within the hospital industry so they can devise effective plans of action in the event of a merger, consolidation, or affiliation (Robinson & Dratler, Corporate Structure And Capital Strategy At Catholic Healthcare West, 2006). The success of most merger or consolidation transactions depends largely on the state of the nation’s economy. As such, it is crucial that senior financial leaders pay particular attention to the extent of hospital liabilities. These liabilities include, but are not limited to capital leases and pension liabilities. Pension liabilities have a tendency to fluctuate dramatically, depending on market performance and rates. Adequate knowledge about the extent of these liabilities will give stakeholders an accurate sense of the feasibility of a potential transaction.

Rules within the healthcare industry have undergone significant changes over last 10 years. Growth is no longer defined by size; rather, it is defined by reduced costs and adequate components for coordinated care. Hospital consolidations today are driven by a need for survival. In order to stay afloat, smaller hospitals are merging with the intent to deliver continued quality care at reduced costs to hospitals as well as consumers. Today’s economy forces hospitals to operate with improved efficiency at reduced costs. It is crucial that healthcare providers make every effort to remain independent, even when faced with a hospital merger or consolidation. Independence is crucial for the success of any hospital; it is also an important component to ensure that the hospital will deliver on its patient care mission (Luke, Luke, & Muller, 2011). Experts predict that hospital consolidations will rise as hospitals battle for survival in today’s economy. The nation’s largest hospitals hold approximately 15 percent of the market share. However, more consolidations are on the horizon for a large majority of smaller hospitals, because they are necessitated by the economy. In addition to an influx of mergers and consolidations, there is also a change in the reasoning behind these transactions. Mergers and consolidations are no longer prompted by the possibility of negotiating better rates; instead they are prompted by expense reduction and improved efficiency. The success of all future consolidations and mergers depend on the hospitals’ ability to understand the life cycle of mergers and acquisitions, and the range of potential merger and acquisition partners. A comprehensive understanding of these factors will ensure a successful transaction that will consequently result in improved care and reduced costs.

References

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