Readers Respond: Trinity Health’s President on Bond Ratings

Readers Respond: Trinity Health’s President on Bond Ratings

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In last week’s edition of the Weekly Gist, I shared an exchange I’d had with the CFO of one of our clients during a meeting of their health system’s board of directors. The topic was the importance of the system’s AA bond rating to the board, and the impact that maintaining that rating might have on the strategic flexibility of the system. I wrote, “As big strategic decisions loom (shifting the business model, taking on risk, responding to disruptive competitors), it’s worth at least asking whether we’ve passed the time for “keeping dry powder”, and whether systems are being held back by conservative financial management.”

One of the true pleasures of our work at Gist Healthcare is engaging in an ongoing dialogue with our clients, readers, and colleagues across the industry. Shortly after sending out the Weekly Gist last week, we heard from long-time friend Mike Slubowski at Trinity Health. He shared his somewhat different (and much more informed!) view of the importance of bond rating to hospital systems, and was kind enough to engage in a brief Q&A over email to expand on his thoughts. We hope you’ll find his perspective as enlightening as we have.

 

Gist Healthcare: How do you think about financial strength for a health system? What characteristics and metrics are most important?

Mike Slubowski: Financial strength is ultimately measured by strong operating cash flow—is the system generating enough cash to cover expenses including debt service, fund depreciation, and to meet capital spending requirements? Operating margin, days’ cash, and leverage ratios are also important metrics of financial strength. We compare these metrics to published ranges from Rating Agencies on rating categories. Finally, what is the organization’s profitability or loss on Medicare? Is the cost structure of the organization (as measured by cost per adjusted discharge or similar metrics) competitive and attractive to payer and purchasers, or is it a high cost organization that’s been living off high commercial payment rates because of its market relevance? That will come back to bite them at some point in the not-too-distant future.  Finally, financial strength is simply a means to an end. In the case of not-for-profit health systems, our mission is to improve the health of the people and communities we serve. Are we using that financial strength to make a measurable difference for our communities? That question has to always be pondered.

In my opinion a system’s bond rating is very important. Our organization strives to maintain an AA rating

GH: How important is the bond rating, and the broader evaluation of the system’s financial outlook by the banking community?

MS: In my opinion a system’s bond rating is very important. Our organization strives to maintain an AA rating. While it is true that the interest rate spreads between, say, an AA and an A rating are small, the reality is that a positive financial outlook and rating from the rating agencies is a “Good Housekeeping Seal of Approval” for a not-for-profit health system. In most instances, acquisitions in not-for-profit healthcare are accomplished by member substitutions, and rather than cash changing hands, the entity being acquired agrees to merge because of future capital investment commitments made by the acquiring entity and their belief that the acquirer will bring economies of scale. They aren’t going to join a system if it has a weak credit rating, because they’d be concerned that the acquiring system wouldn’t be able to fulfill the capital investment commitment.

GH: What are some considerations you’d recommend to health systems thinking about “trading off” a strong bond rating to gain strategic flexibility?

MS: A difficult question, to be sure. First of all, it depends on your starting point. There’s a lot more risk in going from an A- to BBB rating than, say, an AAA rating to an AA rating. Second, it really depends on what strategic opportunities the organization is pursuing—are they opportunities within the wheelhouse of the organization’s leadership competencies? There have been a lot of providers that have ventured into other businesses, such as insurance, long-term care, physician practices and other for-profit ventures, and they have lost a lot of money because they spread themselves too thin and didn’t know how to successfully manage these different businesses. Does the opportunity provide more market relevance? Is the new opportunity accretive? Is there a solid business plan that gives the organization confidence that the new opportunity will be accretive within a defined timeframe? There are a lot of “hockey stick” business plans (i.e., up front losses that predict large profits in later years) that never deliver the desired results. So rating agencies and investors are always wary of these wildly optimistic business plans.

I’m not suggesting that organizations become so conservative that they don’t take risks on strategic opportunities—but it’s important to go into these new ventures with eyes wide open. I think it is important for health care organizations that have been acute-care focused to develop a continuum of services that grow cost-effective home-based services, primary care and other ambulatory services, as well as consumer-focused digital health solutions. They also need to develop clinically-integrated provider networks that are positioned to assume risk for cost and outcomes as payers shift from fee-for-service to value-based payment. Otherwise they will be one-trick-pony dinosaurs while the rest of the world around them is transforming and diversifying.

I’m not suggesting that organizations become so conservative they don’t take risks…but it’s important to go into new ventures with eyes wide open

GH: As health systems take on more risk (strategic, actuarial, operational), how can they best make the case to their financial stakeholders (bondholders, shareholders, public funders) to justify increasing risk?

MS: I think that historical track records are important. Does the organization have an experienced and competent leadership team? Do they recruit leaders with needed skills for new businesses? How has the organization performed with previous new ventures? Have they been able to adjust if things go south? Do their business plans include a sensitivity analysis with upside and downside potential, along with immediate actions they would take if performance does not meet the plan?  Does the opportunity improve market relevance and create a diversified portfolio and/or a continuum of services? At the end of the day, confidence in an organization and its leadership comes from their track record.

 

 

 

Do Most Hospitals Benefit from Directly Employing Physicians?

https://hbr.org/2018/05/do-most-hospitals-benefit-from-directly-employing-physicians

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How can hospitals and health systems generate a return on their investment in their physician enterprises? According to the most recent figures, from the American Medical Association, over 25% of U.S. physicians practiced in groups wholly or partly owned by hospitals in 2016 and another 7% were direct hospital employees. Yet, according to the Medical Group Management Association, hospitals’ multi-specialty physician groups lost almost $196,000 per employed physician.

As a result, some larger health systems’ physician operations are generating nine-figure operating losses, which are major contributors to the deterioration in hospital earnings.  It is time for hospitals or health systems to rethink their strategy for their physician enterprises.

Let’s first revisit why independent physicians were receptive to becoming employees and why hospitals and health systems felt the need to hire them.

The surge in hospital employment of physicians predated Obamacare by at least six years, and had two key drivers. The first was independent baby-boomer physicians — particularly those in primary care — found themselves unable to recruit new partners. Newer physicians, heavily burdened by student debt, were not inclined either to take on entrepreneurial risk or the 60-hour work weeks independent practice entailed.

The second was cuts in Medicare payments for office-based imaging. Thanks to the Deficit Reduction Act of 2005, specialties such as cardiology, orthopedics, and medical oncology that relied on the revenue that imaging generated were hit hard. As a result, many found it advantageous to be employed by hospitals. Under Medicare rules, in addition to professional fees, hospitals can charge a Part B technical fee for their services and therefore can pay practitioners more than they could earn in private practice.

Then, beginning in 2009, the Obama administration’s policies increased the exodus of physicians from private practices to health systems. The “meaningful use” provisions of the HITECH Act of 2009 provided both incentives and penalties for physicians to adopt electronic records, but hospitals and very corporate enterprises had more resources to comply with meaningful-use requirements.

The value-based-payment schemes created by the Affordable Care Act also markedly increased documentation requirements and, as a result, the overhead of practices, driving more physicians into hospital employment models.

There have been a number of reasons hospitals have been hiring physicians. Some, particularly those in rural areas, had no choice but to turn physicians into employees. Retiring independent physicians were leaving large gaps in care in their economically challenged communities. Consequently, hospitals that did not step in to fill the gaps were in danger of closing.

Separately, some hospitals or systems sought to grab business from their competitors by acquiring physicians who hospitalized their patients at competing facilities. These physicians’ inpatient and, particularly, outpatient imaging and laboratory volume generated additional revenues for the acquiring hospital or system.

A third apparent motivation was to corner the local physician market in order to obtain more favorable rates from health insurers. This seemed to have been a major rationale for St. Luke’s Health Systems acquisition of Seltzer Medical Group, Idaho’s largest independent, multi-specialty physician practice group, which led to an anti-trust action.

Yet another reason for making physicians employees was to position the organization for capitated, or value-based, payment. Hospitals believed that “salarying” physicians would help control clinical volumes and thus make it easier to perform in capitated contracts.

Finally, some hospital and system CEOs were tired of negotiating with local independent physician groups or national physician-staffing firms like MedNax and TeamHealth over incomes and coverage of the hospitals’ 24/7 services such as the emergency department, the intensive care unit (ICU), and diagnostic services like radiology and pathology. Building an in-house staff of physicians seemed like an attractive alternative.

Many health systems have gotten into trouble because their strategic rationale for hiring physicians became a moving target.  A hospital system we followed morphed from a ““grab market share” strategy to a “respond to competitive acquisitions” strategy to a “bailout” strategy for loyal independent physicians to a “increase bargaining power with payers” strategy to a “position for value-based care” strategy over a period of eight years. By the time it was done, it was the proud owner of a 700-plus physician group and losses of more than $100 million per year.

Hospitals lose money on their employed physicians because physicians’ compensation plus practice expenses and corporate overhead significantly exceed the collections of practices. These direct losses are, to a degree, an artifact of accounting, because hospitals frequently do not attribute any bonus for meeting “value-based’ contract targets, or incremental hospital surgical, imaging, and lab revenues to physician practice income.

However, even factoring in the accounting issues, much of the losses are attributable to “hosting,” rather than managing, practices effectively.  Many systems employing physicians have done so without developing a cohesive physician organization and lack standardized staffing and operational support functions, such as effective purchasing and supply chain operations, effective scheduling systems, and centralized office locations.

Managing up the return, rather than managing down the loss, is the key to a successful physician strategy. Here’s how to do that.

Establish a clear strategic goal and a target return on investment. Physicians reside at the core of any successful health system. Yet as the Cheshire Cat said in Alice in Wonderland, “If you don’t care where you are going, then it doesn’t matter which way you go!” If you establish strategic goals for the physician enterprise, then the physician organization can be sized and located appropriately. As a result, the physician group may end up either a lot smaller or with a more defensible specialty and/or geographic distribution. Management should then quantify and budget the expected return on the practice’s operational loss.

Strengthen operations. Effective management of the physician group then becomes the essential challenge. For example, revenue-cycle issues such as inconsistent coding or missing data often damage the profitability of the medical group. Are systems in place to assure that medical bills are defensible and correct, and that patients understand what they owe and agree to pay? Seeing that encounters are adequately documented and translated into a fair and timely bill that patients are willing to pay is not rocket science. The return on investment for getting the revenue cycle right is often 3X to 5X.

Revamp compensation and incentives. Medicare’s policy for paying employed physicians will likely come under fresh scrutiny during the Trump administration. It is possible that Medicare’s relatively favorable payment for hospital-employed physicians will be reined in. If that happens, it might require a painful revisiting of employment contracts when they come up for renewal.

Performance incentives in those contracts should also match the strategic goals established above. For example, compensating physicians through a production-based model that encourages them to increase visits, procedures, or hospital admissions, while value-based insurance contracts (like those for accountable care organizations) demand reducing them could damage the overall performance of the health system.

Pursue reality-based contracts with insurers. The Affordable Care Act ushered in a profusion of narrow network, performance-based contracts with private insurers, with significant front-end rate concessions by hospitals. These discounts often far exceeded the potential rewards from the “value based” incentives in the contracts! Larger health systems also rushed to assemble “clinically integrated networks” (CINs), comprising their employed and contracted physicians as well as private practitioners in their markets, to participate in these new contracts. Treating physician group losses and CIN expenses as loss leaders for value-based contracts and then losing yet more money on those contracts, as is happening in many places, doesn’t make sense.

Both enrollment and financial performance under these contracts have been disappointing in most markets. Reviewing and pruning back these contracts, or renegotiating them to provide more adequate rates or to compensate hospitals for patient non-payment is an essential element of an effective physician-enterprise strategy. Hospitals and health systems also should ask: “Is the CIN functioning as intended? Is it adding value that patients notice or is it just an additional layer of administrative expense without compensating benefits for clinicians or patients?

Motivate employed and independent physicians. Finally, hospitals and systems must understand the value they are creating not only for their employed clinical workforce but also for the two-thirds of their physicians who are not full-time employees — those who are contracted, independent participants in CIN’s or in part-time administrative roles. What would motivate all these physicians to want to work with the organization over the long term?

Hospital and systems need a unified physician strategy and operating model that encompasses all these diverse arrangements. Beyond that, they must  engage their physicians in planning and organizing care. Physician are complex, highly trained professionals. They cannot be mere employees; they must be owners of the organization’s goals and strategies.

 

 

 

Reevaluating capital spending strategies

http://www.healthcarefinancenews.com/news/reevaluating-capital-spending-strategies

Medicare Bundled Payments

As U.S. hospitals prepare for value-based reimbursement, even capital investment is shifting away from traditional priorities