Steward Health Care’s Chapter 11 bankruptcy filing onMay 6, 2024, brought back bad memories of another large health system bankruptcy.
On July 21, 1998, Pittsburgh-based Allegheny Health and Education Research Foundation (AHERF) filed Chapter 11. AHERF grew very rapidly, acquiring hospitals, physicians, and medical schools in its vigorous pursuit of scale across Pennsylvania. Utilizing debt capacity and spending cash, AHERF quickly ran out of both, defaulted on its obligations, and then filed for bankruptcy. It was one of the largest bankruptcy filings in municipal finance and the largest in the rated not-for-profit hospital universe.
Steward Health Care is a for-profit, physician-owned hospital company, but its long-standing roots were in faith-based not-for-profit healthcare. Prior to the acquisition by Cerberus Capital Management in 2010, Caritas Christi Health Care System was comprised of six hospitals in eastern Massachusetts. Caritas was a well-regarded health system, providing a community alternative to the academic medical centers in downtown Boston. Over the next 14 years, Steward grew rapidly to 31 hospitals in eight states, most recently bolstered through an expansive sale-leaseback structure with a REIT. Per the bankruptcy filings, the company reported $9 billion in secured debt and leases on $6 billion of revenue.
Chapter 11 bankruptcy filings in corporate America are a means to efficiently sell assets or a path to re-emergence as a new streamlined company. A quick glance at Steward’s organizational structure shows a dizzying checkerboard of companies and LLCs that will require a massive untangling. Further, its capital structure includes both secured debt for operations and a separate and distinct lease structure for its facilities, and in bankruptcy, that signals significant complexity. Bankruptcy filings in not-for-profit healthcare are less common, although it is surprising that the industry did not see an increase after the pandemic. Not-for-profit hospitals that are in distress seem to hang on long enough to find a buyer, gain increased state funding, attain accommodations on obligations, or find some other escape route to avoid a payment default or filing.
Details regarding Steward’s undoing will unfold in the coming weeks as it moves through an auction process. But there are some early takeaways the not-for-profit industry can learn from this:
Remain essential in your local market. Hospitals must prove their value to their constituents, including managed care payers, especially in competitive urban markets, as Steward may have learned in eastern Massachusetts and Miami. Prior strategies of making a margin as an out-of-network provider are no longer viable as patients must shoulder more of the financial burden. Simply put, your organization should be asking one question: does a managed care plan need our existing network to sell a product in our market? If the answer is no, you need to develop strategies that make your hospital essential.
Embrace financial planning for long-term viability. Without it, a hospital or health system will be unable to afford the capital spending it needs to maintain attractive, patient-friendly, state-of-the art facilities or absorb long-term debt to fund the capital. Annual financial planning is more than just a trendline going forward. The scenarios and inputs must be well-founded, well-grounded in detail, and based on conservative assumptions. Increasing attention has to be paid to disrupters, innovators, specialized/segmented offerings, and expansion plans of existing and new competitors. Investors expect this from not-for-profit borrowers. Higher-performing hospitals and health systems of all sizes do this well.
Build capital capacity through improved cash flow. It is undoubtedly clear that Steward, like AHERF, was unable to afford the capital and debt they thought they could, either through flawed financial planning of its future state or, more concerning, the complete absence of it. Or they believed that rapid growth would solve all problems, not detailed financial planning, the use of benchmarks, or a sharp focus on operations. Increasing that capacity through sustained financial performance will allow an organization to de-leverage and build capital capacity.
When the case studies are written about Steward, a fact pattern will be revealed that includes the inability or unwillingness to attain synergies as a system, underspending on facility capital needs given a severe liquidity crunch, labor challenges, and a rapid payer mix shift.
Underlying all of this will undoubtedly be a failure of governance and leadership as we saw with AHERF. It will also likely indicate that one of the most precious assets healthcare providers may have is the management bandwidth to ensure strategic plans are appropriately made, tested, monitored, and executed.
While Steward and AHERF may be held up as extreme cases, not-for-profit hospital governance must continue to focus on checks-and-balances of management resources. Likewise, management must utilize benchmarks, data, and strong financial planning, given the challenges the industry faces.
This is National Hospital week. It comes at a critical time for hospitals:
The U.S. economy is strong but growing numbers in the population face financial insecurity and economic despair. Increased out-of-pocket costs for food, fuel and housing (especially rent) have squeezed household budgets and contributed to increased medical debt—a problem in 41% of U.S. households today. Hospital bills are a factor.
The capital market for hospitals is tightening: interest rates for debt are increasing, private investments in healthcare services have slowed and valuations for key sectors—hospitals, home care, physician practices, et al—have dropped. It’s a buyer’s market for investors who hold record assets under management (AUM) but concerns about the harsh regulatory and competitive environment facing hospitals persist. Betting capital on hospitals is a tough call when other sectors appear less risky.
Utilization levels for hospital services have recovered from pandemic disruption and operating margins are above breakeven for more than half but medical inflation, insurer reimbursement, wage increases and Medicare payment cuts guarantee operating deficits for all. Complicating matters, regulators are keen to limit consolidation and force not-for-profits to justify their tax exemptions. Not a pretty picture.
And, despite all this, the public’s view of hospitals remains positive though tarnished by headlines like these about Steward Health’s bankruptcy filing last Monday:
The public is inclined to hold hospitals in high regard, at least for the time being. When asked how much trust and confidence they have in key institutions to “to develop a plan for the U.S. health system that maximizes what it has done well and corrects its major flaws,” consumers prefer for solutions physicians and hospitals over others but over half still have reservations:
A Great Deal
Some
Not Much/None
Health Insurers
18%
43%
39%
Hospitals
27%
52%
21%
Physicians
32%
53%
15%
Federal Government
14%
42%
44%
Retail Health Org’s
21%
51%
28%
The American Hospital Association (AHA) is rightfully concerned that hospitals get fair treatment from regulators, adequate reimbursement from Medicare and Medicaid and protection against competitors that cherry-pick profits from the health system.
It can rightfully assert that declining operating margins in hospitals are symptoms of larger problems in the health system: flawed incentives, inadequate funding for preventive and primary care, the growing intensity of chronic diseases, medical inflation for wages, drugs, supplies and technologies, the dominance of ‘Big Insurance’ whose revenues have grown 12.1% annually since the pandemic and more. And it can correctly prove that annual hospital spending has slowed since the pandemic from 6.2% (2019) to 2.2% (2022) in stark contrast to prescription drugs (up from 4% to 8.4% and insurance costs (from -5.4% to +8.5%). Nonetheless, hospital costs, prices and spending are concerns to economists, regulators and elected officials.
National health spending data illustrate the conundrum for hospitals: relative to the overall CPI, healthcare prices and spending—especially outpatient hospital services– are increasing faster than prices and spending in other sectors and it’s getting attention: that’s problematic for hospitals at a time when 5 committees in Congress and 3 Cabinet level departments have their sights set on regulatory changes that are unwelcome to most hospitals.
My take:
The U.S. market for healthcare spending is growing—exceeding 5% per year through the next decade. With annual inflation targeted to 2.0% by the Fed and the GDP expected to grow 3.5-4.0% annually in the same period, something’s gotta’ give. Hospitals represent 30.4% of overall spending today (virtually unchanged for the past 5 years) and above 50% of total spending when their employed physicians and outside activities are included, so it’s obvious they’ll draw attention.
Today, however, most are consumed by near-term concerns– reimbursement issues with insurers, workforce adequacy and discontent, government mandates– and few have the luxury to look 10-20 years ahead.
I believe hospitals should play a vital role in orchestrating the health system’s future and the role they’ll play in it. Some will be specialty hubs. Some will operate without beds. Some will be regional. Some will close. And all will face increased demands from regulators, community leaders and consumers for affordable, convenient and effective whole-person care.
For most hospitals, a decision to invest and behave as if the future is a repeat of the past is a calculated risk. Others with less stake in community health and wellbeing and greater access to capital will seize this opportunity and, in the process, disable hospitals might play in the process.
Near-term reactive navigation vs. long-term proactive orchestration–that’s the crossroad in front of hospitals today. Hopefully, during National Hospital Week, it will get the attention it needs in every hospital board room and C suite.
PS: Last week, I wrote about the inclination of the 18 million college kids to protest against the healthcare status quo (“Is the Health System the Next Target for Campus Unrest?” The Keckley Report May 6, 2024 www.paulkeckley.com). This new survey caught my attention:
According to the Generation Lab’s survey of 1250 college students released last week, healthcare reform is a concern. When asked to choose 3 “issues most important to you” from its list of 13 issues, healthcare reform topped the list. The top 5:
Health Reform (40%)
Education Funding and access (38%)
Economic fairness and opportunity (37%)
Social justice and civil rights (36%)
Climate change (35%)
If college kids today are tomorrow’s healthcare workforce and influencers to their peers, addressing the future of health system with their input seems shortsighted. Most hospital boards are comprised of older adults—community leaders, physicians, et al.
And most of the mechanisms hospitals use to assess their long-term sustainability is tethered to assumptions about an aging population and Medicare.
College kids today are sending powerful messages about the society in which they aspire to be a part. They’re tech savvy, independent politically and increasingly spiritual but not religious. And the health system is on their radar.
The new year is always an ideal time for healthcare leaders to reflect on the state of our industry and their own organizations, as well as the challenges and opportunities ahead.
As the CEO of a large health system, I always like to reflect on one basic question at the end of each year: Are we staying true to our mission?
Certainly, maintaining an organization’s financial health must always be a priority but we should also never lose sight of our core purpose. In a business like ours that has confronted and endured a global pandemic and immense financial struggles over the past several years, I recognize it’s increasingly difficult to maintain our focus on mission while trying to find ways to pay for rising labor and supply costs, infrastructure improvements needed to remain competitive and other pressures on our day-to-day operations.
After all, the investments we need to make to promote community wellness, mental health, environmental sustainability and health equity receive little or no reimbursement, negatively impacting our financial bottom lines. During an era of unprecedented expansion of Medicaid and Medicare, we get less and less relief from commercial insurers, whose denial and delay tactics for reimbursing medical claims continue to erode the stability of many health systems and hospitals, especially those caring for low-income communities.
Despite those enormous pressures, it’s imperative that we continue to support underserved communities, military veterans struggling with post-traumatic stress, and intervention programs that help deter gun violence and addiction.
The list of other worthy investments goes on and on: charity care to uninsured or underinsured patients who can’t pay their medical bills, funding for emergency services that play such a critical role during public health emergencies, nutritional services for families struggling to put food on the table, programs that combat human trafficking and support women’s health, the LGBTQIA+ community and global health initiatives that aid Ukraine, the Middle East and other countries torn apart by war, famine and natural disasters.
We must also recognize the key role of healthcare providers as educators. School-based mental health programs are saving lives by identifying children exhibiting suicidal behaviors, anger management issues and other troublesome behaviors. School outreach efforts have the added benefit of helping health systems and hospitals address their own labor shortages by introducing young people to career paths that will help shape the future healthcare workforce.
Without a doubt, the “to-do” list of community health initiatives that support our mission is daunting. We can’t do it all alone, but as the largest employers in cities and towns across America, health systems and hospitals can serve as a catalyst to get all sectors of our society — government, businesses, schools, law enforcement, churches, social service groups and other community-based organizations — to recognize that “health” goes far beyond the delivery of medical care.
The health of individuals, families and communities hinges on the prevalence of good-paying jobs, decent and affordable housing, quality education, access to healthy foods, medical care, transportation, clean air and water, low prevalence of crime and illicit drugs, and numerous other variables that typically depend on the zip codes where we live. Those so-called social determinants of health are the driving factors that enable communities and the people who live there to either prosper or struggle, resulting in disparities that are the underlying cause of why so many cities and towns across the country fall into economic decay and become havens for crime and hotbeds for gun violence, which shamefully is now the leading cause of death for children and adolescents.
To revive these underserved communities, many of which are in our own backyards, we have to look at all of the socioeconomic issues they struggle with through the prism of health and use the collective resources of all stakeholders to bring about positive change.
Health is how we work together to build a sense of community. Having a healthy community also requires everyone doing what they can to tone down the political rhetoric and social media-fueled anger that is polarizing our society. Health is bringing back a sense of civility and respect in our public discourse, and promoting the values of honesty, decency and integrity.
As healthcare providers and respected business leaders, we should all make a New Year’s resolution to stay true to our mission and do what we can within our communities to bring oxygen to hope, optimism and a healthier future.
In behavioral economics, the sunk cost fallacy describes the tendency to carry on with a project or investment past the point where cold logic would suggest it is not working out. Given human nature, the existence of the sunk cost fallacy is not surprising. The more resources—time, money, emotions—we devote to an effort, the more we want it to succeed, especially when the cause is an important one.
Under normal circumstances, the sunk cost fallacy might qualify as an interesting but not especially important economic theory. But at the moment, given that 2022 will likely be the worst financial year for hospitals since 2008 and given that the hospital revenue/expense relationship seems to be entirely broken, there is little that is theoretical about the sunk cost fallacy. Instead, the sunk cost fallacy becomes one of the most important action ideas in the hospital industry’s absolutely necessary financial recovery.
Historically, cases of the sunk cost fallacy can be relatively easy to spot. However, in real time, cases can be hard to identify and even harder to act on. For hospital organizations that are subsidizing underperforming assets, identifying and acting on these cases is now essential to the financial health of most hospital enterprises.
For example, perhaps the asset that isunderperforming is a hospital acquired by a health system. (Although this same concept could apply to a service line or a related service such as a skilled nursing facility, ambulatory surgery center, or imaging center.) The costs associated with integrating an acquired hospital into a health system are typically significant. And chances are, if the hospital was struggling prior to the acquisition, the purchaser made substantial capital investments to improve the performance.
As time goes on, if the financial performance of the entity in question continues to fall short, hospital executives may be reluctant to divest the asset because of their heavy investment in it.
This understandable tendency can lead the acquiring organization to throw good money after bad. After all, even when an asset is underperforming, it can’t be allowed to deteriorate. In the case of hospitals, that’s not just a matter of keeping weeds from sprouting in the parking lot. The health system often winds up supporting an underperforming hospital with both working capital and physical capital, which compounds the losses.
And the costs don’t stop there, because other assets in the system are supporting the underperforming asset. This de facto cross-subsidy has been commonplace in hospital organizations for decades. Such a cross subsidy was probably never sustainable, but it is even less so in the current challenging financial environment.
This is a transformative period in American healthcare, when hospital organizations are faced with the need to fundamentally reinvent themselves both financially and clinically. The opportunity costs of supporting assets that don’t have an appropriate return are uniquely high in such an environment. This is true whether the underperforming asset is a hospital in a smaller system, multiple hospitals in a larger system, or a service line within a hospital.
The money that is being funneled off to support underperforming assets may be better directed, for example, toward realigning the organization’s portfolio away from inpatient care and toward growth strategies. In some cases, the resources may be needed for more immediate purposes, such as improving cash flow to support mission priorities and avoiding downgrades of the organization’s credit rating.
The underlying principle is straightforward:
When a hospital supports too many low-performing assets, the capital allocation process becomes inefficient. Directing working capital and capital capacity toward assets that are dilutive to long-term financial success means that assets that are historically or potentially accretive don’t receive the resources they need to grow and thrive. The underlying principle is a clear lose-lose.
In the highly challenging current environment, it is especially important for boards and management to recognize the sunk cost fallacy and determine the right size of their hospital organizations—both clinically and financially.
Some leadership teams may determine that their organizations are too big, or too big in the wrong places, and need to be smaller in order to maximize clinical and balance-sheet strength. Other leadership teams may determine that their organizations are not large enough to compete effectively in their fast-changing markets or in a fast-changing economy.
Organizational scale is a strategy that must be carefully managed. A properly sized organization maximizes its chances of financial success in this very difficult inflationary period. Such an organization invests consistently in its best performing assets and reduces cross-subsidies to services and products that have outlived their opportunity for clinical or financial success.
Executives may see academic economic theory as arcane and not especially relevant. However, we have clearly entered a financial moment when paying attention to the sunk cost fallacy will be central to maintaining, or recovering, the financial, clinical, and mission strength of America’s hospitals.
HENRY KOTULA 