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Community hospitals reappraise destiny

Phoenixville Hospital’s Executive Director Kevin Mahoney

By Christopher Guadagnino, Ph.D.

More recently, some community hospitals that joined systems have become unhappy with the arrangement and have broken it – either to reestablish independence or to pursue other system arrangements.

The latest arrangement, being pursued by Phoenixville Hospital in Chester County, appears to be a hybrid approach whereby the hospital has been acquired by Brentwood, Tenn.’s Community Health Systems Inc. – a national for-profit chain – but is retaining several clinical programs through an affiliation with its prior owner, the University of Pennsylvania Health System.

Those community hospitals that struggle to survive independently face the need to stay competitive with larger tertiary institutions by investing in expertise, technology and capital improvement projects, but must somehow find the means to pay for those investments.

While it appears that a “join or die” imperative no longer dominates as it once did, particular market variables – e.g., location, competition, community loyalty, payor mix, capital needs, and service demand – are dictating which option a community hospital will select, with each bringing advantages and disadvantages, both for the institution and the physicians who practice there.

The hospital business climate in Pa. punctuates the challenge of any option, as 48 percent of the state’s general acute care hospitals were operating in the red in 2003, up from 42 percent in 2002 and 34 percent the previous year, according to the Pennsylvania Health Care Cost Containment Council. Hospitals’ investment income saw a drastic decline in the last two years to $30.5 million in 2003, from $46.5 million in 2002 and $265.6 million in 2001, and the Council noted that nonprofit hospitals in particular rely heavily on investments and charitable donations, and it cautioned that hospitals could have trouble finding money to upgrade facilities or equipment.

For-Profit Ownership

As of Aug. 1, ownership of the 143-bed Phoenixville Hospital was transferred from the University of Pennsylvania Health System to the investor-owned Community Health Systems Inc. (CHS). Events leading up to the transfer may illustrate market dynamics felt by other community hospitals that had joined academic medical center systems across Pa., while the new arrangement retaining three hospital entities – a community hospital, a national for-profit owner and an academic medical center running several clinical programs – appears to be unique in the Commonwealth.

Phoenixville was purchased by Penn in 1997, shortly after Penn made its first physician practice acquisition – 30 physicians at Phoenixville, says Phoenixville Hospital’s Executive Director Kevin Mahoney. Penn had invested heavily in Phoenixville, which Mahoney said had a 27 percent nurse vacancy rate, an ER that was closed 20 percent of the time because of overcrowding, and equipment that was outdated.

Penn spent $50 million in capital improvements, primarily over the past four years, including a large surgicenter eight miles north of the Phoenixville campus, a modernized cancer center, and new open heart and neonatal ICU programs. Penn increased the hospital’s number of acute care beds by 30 percent by converting skilled nursing beds, doubled the hospital’s outpatient visits and nearly doubled the number of ER visits, Mahoney adds.

No matter how much Penn spent, it could not keep pace with the needs of Phoenixville Hospital, which Mahoney says has always been profitable, but is overwhelmed by the population growth in its region. Constraints on Penn – including the failure of capitation as a reimbursement model to arrive to the extent expected, the suspension of an expensive disease management system to manage capitated patients, and the expenditure of millions of dollars on physician practice purchases – meant that many improvements Penn intended to make did not occur, Mahoney notes.

Phoenixville, a community hospital that now has three MRIs and a 14-to-20 day patient waiting list for them, and a patient demand requiring a third CAT scanner, had outgrown the ability of its academic owner to supply it with the capital it needed to fulfill the requirements of its community, says Mahoney. A committee of physicians, administrators and board members evaluated the options of staying with Penn, returning to independent status and joining nonprofit and for-profit hospital systems, concluding that an investor-owned company could most easily supply Phoenixville’s driving need for a large amount of capital, Mahoney notes.

The committee believed that the amount the hospital would have to borrow as a freestanding entity – $85 million to $100 million over the next six years – would put its future in jeopardy, while a nonprofit hospital network’s ability to borrow – typically through bond issues and fundraising – was still limited compared to a for-profit’s ability to raise capital through stock offerings, Mahoney notes. Penn, which has obligations to four hospitals and over 1,000 physicians, would have to invest nearly an entire year’s capital budget in one entity if Phoenixville remained in its system, Mahoney adds.

“We’re seeing academic medical centers that have difficulty with capital investment backing out of community hospital operations to concentrate on home base operations and fulfill their academic missions,” says CHS Senior Vice President Gary Newsome. CHS’s business model, Newsome explains, is to look for communities with a stable or growing population and hospitals with significant migration of services to other hospitals, then retool the facility and recruit physicians to keep those services within the hospital. The cost of capital to accomplish these goals can be lower to a large for-profit company like CHS, which now owns 73 hospitals in 22 states, than it is to nonprofit hospitals or systems, which often depend on favorable bond ratings to raise capital, says Newsome.

From a physician standpoint, the ability of CHS to meet Phoenixville’s capital requirements outweighed the advantages of more flexible decision-making as a freestanding hospital, according to Dennis Monteiro, M.D., Phoenixville’s medical staff president. When Phoenixville was independent, he says, a physician who wished to start a new program or wanted a new piece of capital equipment only needed to go into the CEO’s office and make an appeal. When even a local system like Penn was involved, such appeals had to survive an added layer of decision-making at the system level, he says, noting that now, only certain decisions will be made locally, while most will be “turfed to Tennessee.” The flip side, notes Monteiro, is that “It doesn’t make a difference that a local CEO can make a decision about new OR suites if you don’t have the money to do it.”

CHS has agreed to spend $90 million on capital improvements at Phoenixville over the next six to eight years, or up to $120 million if the plan calls for replacing the existing hospital with a new facility, says Newsome. Other upgrades slated for Phoenixville, says Monteiro, include new OR suites, an obstetrics program, and an increased presence of specialties such as neurosurgery and other surgical subspecialties.

Having worked at for-profit hospitals, Monteiro doesn’t see them dictating the practice of medicine or slowing down care, and he says the for-profit hospital companies that Phoenixville interviewed were not interested in owning or controlling physician practices. CHS retains local boards with medical staff representation to participate in decision-making, and does not “brand” its hospitals as CHS institutions, typically retaining the facility’s original name, says Newsome.

The Phoenixville acquisition has spawned a new configuration for hospital affiliations in Pa. While CHS now owns Phoenixville, Penn had introduced a number of its clinical programs to the hospital before the transfer, and the entities have agreed to allow Penn to continue to use its physicians to provide clinical services at Phoenixville, including oncology, cardiac surgery, radiology, pathology, reproductive endocrinology, physical therapy, PET scanning, and sleep center services, says Mahoney. Under the arrangement, Penn physicians can also continue to send Phoenixville’s patients to Penn for clinical trials, he notes.

CHS, which now owns six hospitals in Pa., saw no sense in disrupting key services that were already in place at Phoenixville, and the entities see mutual benefit from the standpoint of maintaining patient referrals between Phoenixville and Penn and splitting reimbursement, with professional fees going to physicians and facility fees going to the hospital, says CHS Senior Vice President Gary Newsome, who notes that CHS forged a similar arrangement with an academic medical center for the first time two years ago in Tennessee.

CHS sees the arrangement with Penn as a potential opportunity to access Penn’s resources to support its other hospitals in the greater Philadelphia area, although no plans are yet on the drawing board, says Newsome.

For-profit hospital companies have an impressive track record managing the bottom line of most of the hospitals they have acquired in Pa. The Pennsylvania Health Care Cost Containment Council noted that in FY 03, of the 16 general acute care hospitals that had been in operation for a full fiscal year following their acquisition by a for-profit corporation, 11 have shown an improvement in their total margin. The Council noted that none of those hospitals had the internal funds or the ability to obtain the level of debt financing necessary to make capital improvements prior to acquisition.

Pottstown Memorial Medical Center in Montgomery County, which was purchased by CHS in July 2003, had been barely above the break-even point before the acquisition and has seen its margins improve overall during the past year, has received $3 million from CHS in new equipment, and last month broke ground on a $10 million ER – its first major capital improvement project in a decade – for which the independent hospital for years had tried to raise funds, says Pottstown CEO Marty Smith.

Pottstown also benefited from CHS’s in-house physician recruitment expertise and practice startup subsidies, adding nine physicians in the past year, and Smith says the hospital is close to signing an ob/gyn and an orthopedic surgeon, notoriously difficult specialties to recruit.

Before its acquisition by CHS three years ago, Brandywine Hospital in Chester County had a negative 10 percent operating margin, which has much improved since then, according to Brandywine’s CEO Don Henderson. Three reasons why Brandywine chose the for-profit hospital route, he says, were access to capital to refurbish the aging facility, access to expert billing and collection services to rejuvenate its cash flow, and access to national clinical practice and consulting leadership – which, for example, gave clear and concise guidance on what the hospital needed to do to become compliant with HIPAA regulations, and developed services at the hospital to retain patients that had been going elsewhere for care – including interventional cardiology, wound care and PET scanning.

Brandywine also obtained access to a robust information technology system used throughout CHS hospitals, with which its clinicians can order and quickly receive the results of diagnostic studies electronically, then archive the results, says Henderson.

While Henderson notes that responsibility for decisions affecting the bottom line of the hospital now reside with the system, he says that physicians now comprise nearly half of the hospital’s governing board, up from 20 percent before CHS acquired the hospital, and CHS engages in annual strategic planning with the board.

Academic Medical Center Systems

Many of the resources offered by national hospital chains to their community hospital acquisitions are also available from health systems anchored by academic medical centers. Before Pittsburgh’s Shadyside Hospital affiliated with the University of Pittsburgh Medical Center Health System in 1997, it had been experiencing falling reimbursements and rising costs and had looked at possible partnerships with other community hospitals, only to find that their balance sheets were no better, according to then-Vice President David Martin. The university system not only had strong academic programs, but also the strength of sheer numbers to leverage purchasing power with manufacturers and suppliers, he says.

Since 1997, Shadyside has been represented on UPMC’s governance structure; its expenses – administrative, materials, legal and PR – have been lowered, its admissions have grown by 20 percent, its outpatient activity has flourished, research opportunities have materialized through the Hillman Cancer Center and teaching programs have been made more accessible at Shadyside, Martin notes.

UPMC St. Margaret had a parallel rationale for merging with an academic medical center – seeking fiduciary strength in the size of the UPMC system, says Martin, who is currently CEO of UPMC St. Margaret. The hospital’s admissions have grown 28 percent since the end of FY 02, its operating margins have been well in the black and UPMC has made capital investments in the hospital, adding four new ORs, a new emergency room project scheduled for completion at the end of the year, and an electronic health record system to be launched this fall with a drug barcoding system to follow in the near future, Martin says.

In addition to its own quality management program, UPMC St. Margaret can also share in a systemwide clinical benchmarking of physicians and services across some 20 hospitals, Martin adds.

Joining two cultures did produce anxieties during the first couple of years of Shadyside’s union with UPMC, and Shadyside physicians feared that UPMC would remove key clinical services, says Martin. Those fears were allayed as it became clear that Shadyside’s services complemented the health system, he adds.

Changing market factors can sometimes break the bond between a community hospital and a larger health system. Wanting to be associated with a widely recognized academic health system, Lee Regional Hospital in Johnstown signed an affiliation agreement with UPMC eight years ago and fully merged last year, with the agreement that the former owner of now-UPMC Lee Regional Hospital preserved the ability to regain local control of the hospital if UPMC ever considered selling it to another entity, according to John Augustine, chair of Lee Regional Health System – the hospital’s former owner.

That scenario has materialized, as UPMC was approached at the end of May by the Conemaugh Health System, which expressed an interest in purchasing Lee Regional. Augustine says the hospital’s medical staff wanted to try to stay independent, that hospital employees feared layoffs if it were to merge with Conemaugh, and that his local health system board unanimously agreed to pursue the possibility of regaining control of the hospital, exercising its contractual right to do so.

Augustine says that Lee Regional has benefited from UPMC’s services and clinical expertise and has been operating in the black, but has been shouldering large “enterprise expenses” he says UPMC adds each month to its hospitals’ balance sheets, which he says has put Lee Regional out of the black.

The hospital has hired consultants to review the viability of continuing as an independent institution, while Augustine acknowledges that many challenges lie ahead – including a declining patient population, competition of a nearby hospital twice Lee’s size, and low reimbursement from third-party payors. But the hospital didn’t want to roll over without a sustained effort to be independent, and is currently examining what changes might boost its operating margins and how much it would need to borrow to survive on its own, says Augustine.

While hospital systems can refinance the debts of smaller hospitals they acquire and bring efficiencies to allow them to stay in business, there is not a lot of evidence that joining a system – whether a for-profit or an academic medical center system – generically improves an individual hospital’s financial performance, or that systems perform better than do individual hospitals, according to Lawton R. Burns, Ph.D., MBA, a senior fellow of the Leonard Davis Institute of Health Economics and director of the Wharton Center for Health Management and Economics.

For a hospital struggling with multiple demands, such as government regulations and compliance issues, payors ratcheting down reimbursement, demands from physicians and community members to add new services, and limitations on access to capital, “It’s a natural strategy to fall back into somebody’s bigger arms,” says Burns.

Community Hospital Systems

An approach to eliminating competition, achieving economy of scale through consolidation and some purchasing clout through volume, while not sacrificing local control to an academic system or to a national corporation, is for community hospitals to form their own regional networks.

As of July 1, the freshly merged Westmoreland Latrobe Health Partners has united Westmoreland Health System, which includes Westmoreland Regional Hospital and Frick Hospital, with Latrobe Area Hospital, creating a single health care system of more than 700 beds at three main facilities in Latrobe, Greensburg and Mt. Pleasant, with various diagnostic and treatment centers throughout Westmoreland County.

The entities said they anticipate challenging economic conditions to continue for hospitals in the state, as well as a utilization spike over the next decade due to an aging patient population, and they reviewed various options to address these factors –including joining large health systems based in Pittsburgh. Westmoreland and Latrobe concluded that combining institutions with strong balance sheets could reduce competition and achieve combined operating efficiencies, likely including consolidation of some services as yet to be determined, according to David S. Gallatin, CEO of the merged entity.

Westmoreland had previously undertaken some consolidation measures, including the closure of the maternity unit at Frick Hospital, and Gallatin notes that the inpatient psychiatric services for the new system will be consolidated by October, with adult services to be offered at Westmoreland and pediatric and adolescent services at Latrobe. Gallatin hopes to work with the medical staffs, which will be kept separate at each hospital, to look at combining inefficient operations while trying to minimize disruption to physicians.

The hospitals’ FY 03 performance – which shows a combined operating loss of $13 million – does not reflect the institutions’ investments and reserves which give the new system confidence that it can access the capital it needs to weather any future storm and, along with substantial improvements on operations in FY 04 and the hope of additional efficiencies to come, that it faces a bright future, says Gallatin.

A key driver of the decision to form a regional network was to retain local governance of a community-owned and operated system whose sole interest is the community they serve, rather than having to answer to the competing commitments of an academic system that has to treat decisions in light of the overall interests of a large, geographically dispersed set of hospitals, says Douglas Clark, the merged entity’s president. If a community hospital subsidiary of a large academic system is not producing the patient volume or the teaching and research benefit expected by the system, it might become disenfranchised, he notes. “Our system doesn’t face that,” Clark adds.

The new system can still build mutually beneficial collaborations with other providers, including academic ones, and can be more responsive in coordinating the care needed for its particular markets, Clark maintains.

Another fresh merger as of July, involving Carbon County’s two hospitals, has combined Palmerton Hospital and Gnaden Huetten Memorial Hospital into the Blue Mountain Health System. The two hospitals, which are about 10 miles apart, already share a large number of physicians, and the anticipated consolidation of services – such as one planned for obstetrics – brings the promise of a larger volume of procedures for physicians in the community, says Tom Tachovsky, M.D., Blue Mountain’s medical director. A shift to complementary rather than duplicative services, combined with projected savings from joint purchasing and staffing, will allow the hospitals to make better use of community resources, he expects.

Palmerton and Gnaden Huetten hospitals have seen a significant trend of declining census over the past two or three years, losing cardiac, colorectal and reconstructive surgery patients to larger medical centers, says Tachovsky, and the merged entity hopes that a larger combined patient base will make it easier to recruit subspecialists such as a full-time cardiologist, neurologist, endocrinologist and infectious disease specialist – all of whom currently travel on a consultation basis from St. Luke’s Hospital in Bethlehem or Lehigh Valley Hospital in Allentown.

A medical staff development plan will also address, through recruitment initiatives, the aging physician staff at the two hospitals, while Tachovsky hopes the merged entity will also subsidize greater use of physician extenders and certified registered nurse practitioners in the emergency and operating rooms, which have previously seen only scattered use because they are an additional expense for surgeons, Tachovsky adds.


A key impediment to community hospital independence was removed in the mid-1990s with the sunset of Pa.’s Certificate of Need statute, notes Deborah Robinson, Esq. a shareholder of Houston Harbaugh P.C. in Pittsburgh. Before then, many institutions wanted to be connected with a hospital or system that could do open heart surgery, whereas now they have the opportunity to bring the potentially lucrative service to their own community, along with cardiac rehab services – which patients prefer to receive in the community – and less invasive imaging services that have not been previously available, Robinson notes. An aging patient population is also less inclined to travel, which may further benefit a local hospital, Robinson adds.

Given the right equilibrium of market factors, such as a location with a captive catchment area and relative lack of competition, community loyalty, favorable payor mix and service demand, and the ability to meet capital needs, a community hospital can flourish as a freestanding entity.

Some independent hospitals have never been part of a system while some have considered joining and decided not to, and others have joined and decided to return to independence.

Butler Memorial Hospital, in Butler County, has never joined a system in its 100-plus-year history and sees viability in remaining independent for a long time, according to its CEO Joe Stewart. Because of the high-end care Butler is able to offer its community, its nearest competition is 35 miles away in downtown Pittsburgh, says Stewart. The hospital is in the fifth year of its open heart surgery program, which he says is rapidly growing its volume and is achieving excellent outcomes. Word-of-mouth confidence in the hospital’s quality outcomes has been a key patient draw across many of its services, says Stewart.

Other factors in Butler’s favor include a good payor mix – composed of one-half Medicare, one-third managed care, one-tenth Medicaid and a relatively small proportion of uncompensated care – and a patient population that is growing from two to eight percent, depending on diagnostic category, says Stewart.

With an operating margin of better than five percent for the past four years and the wherewithal to invest up to $150 million in new capital projects – the needs for which Stewart says are currently under examination – Butler appears to be financially outperforming most Pa. hospitals in any arrangement. Its fiscal health gives Butler a favorable borrowing profile, which Stewart says some hospitals “whose financial airways have become blocked” could only obtain by joining a network for their very survival.

Butler has also formed joint ventures with its physicians for ambulatory surgery and outpatient cancer facilities, says Stewart.

Stewart attributes his hospital’s financial and clinical success largely to the personalized rapport the administration is able to forge with its physicians in its “quest for the best quality at the best prices,” and to the flexibility, afforded by independence, to control both. The hospital is able to control the variables of care that account for excess cost, for example, by co-creating clinical protocols with its physicians without the need for complicated and bureaucratic studies. That approach improved the outcomes for inpatient diabetics simply by revealing that their diet had not been standardized, Stewart illustrates.

The autonomy that Butler is able to grant physicians in collaborative cost and quality management initiativess must not be underestimated, Stewart maintains, as physicians become disengaged from health care when their power to control their own destiny is eroded by top-down practice guidelines, protocols and care rationing rules. Instead, Stewart says the hospital presents itself as a “medical concierge” to physicians, sitting down with its top admitters to ask them what practice issues matter most to them, and what roadblocks the hospital could remove.

Another freestanding hospital, one of only three in Allegheny County, Jefferson Regional Medical Center had considered joining the UPMC system a few years ago, when it had started to lose money on operations – including some losses from physician practices it had acquired, according to Thomas P. Timcho, the hospital’s interim president and CEO.

The hospital hired the Hunter Group consulting firm and was told that UPMC was a strong and viable system to join, but also that Jefferson Regional had all of the pieces it needed to put its own house in financial order, says Timcho. After receiving strong community support for remaining independent, Jefferson Regional’s board decided to implement a turnaround plan for the hospital – primarily by adding services to grow revenue – which has brought the hospital from a $12 million loss on operations in FY 02 to the anticipation of being in the black by FY 05, Timcho notes.

The hospital added an open heart surgery program in 2002, which has grown its patient volume favorably, has opened a new cardiovascular unit, and has revitalized its orthopedics program, working with its physicians to market the program, says Timcho. The hospital has been successful in cross-subsidizing lower-paying specialties, such as psychiatry, with relatively profitable specialties, such as cardiac care, Timcho adds.

The hospital is also pursuing alliances, such as a radiation oncology program joint venture with UPMC, scheduled to open on Jefferson Regional’s campus in early 2005.

Although Jefferson Regional is ten miles from its nearest competitor, the area’s hilly terrain acts as more of a topographical barrier than the distance would suggest. That relative separation from competition, combined with a quality of life afforded by attractive South Hills neighborhoods, have made it easier to recruit physicians and their families to the region, says Timcho. At least four major cardiology groups and three major orthopedic groups practice at Jefferson Regional, and recruitment competition among those groups has supplied the hospital with a large number of physicians, he adds.

The hospital also enjoys a culture similar to that of a family, Timcho notes, as many of the community’s patients – which include a high proportion of elderly – are relatives of hospital staff. Many have been comforted by the availability of an open heart program in the heart of their community, which Timcho says has had a “halo effect” on their perception of the hospital’s other services. A loyal nursing staff has also meant low turnover – about nine percent – and far less need to rely on agency nurses, whose salaries can be double or triple that of of full-time nurses, Timcho notes.

Only 27 years old, Jefferson Regional has also been spared the need to spend potentially huge sums to upgrade its physical plant, as many 80-to-100-year-old community hospitals have had to do, Timcho adds.

There are community hospitals, having found that life within a system did not live up to expectations, that have decided to return to independent status, as did Lower Bucks Hospital in June 2002, after being part of the Temple University Health System for five years.

After Temple had put Lower Bucks up on the selling block because the hospital did not generate the profits expected, Lower Bucks’ performance improved dramatically when financial control was transferred to a local board in 2002, according to Austin Cleveland, CEO of Lower Bucks Hospital since 2003, when the hospital was taken off the market to pursue freestanding status.

After having been marginally in the red, Lower Bucks is in its third profitable year, which Augustine attributes to decision-making – regarding funding, investments and services – that is now more flexible and responsive to the needs of the institution and its community. For example, going through the local board to make a decision on equipment purchases like an MRI produced faster and easier results than the long process of paperwork and justification required under the system model, says Augustine, adding that, “In a major system, the decision to buy a $2 million magnet for a little hospital is a long process.”

Lower Bucks’ market share is growing, and it has recently received a $5 million state matching grant to double the size of its ER, which produces 70 percent of the hospital’s admissions, according to Augustine. The hospital’s favorable payor mix, which includes roughly 45 percent Medicare and a low four percent uncompensated care, is another crucial element in the hospital’s success, he says.

The hospital has recently added services that its market survey and physicians said the community needed, including a new MRI, CT scanner, and electrophysiology services, says Augustine. The hospital also has greater freedom than it did before to choose clinical affiliations with systems that offer the services it needs – such as an open heart surgical team from Temple and a cardiovascular surgeon from Cooper Health System in New Jersey, he adds.

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