Distress is Widespread as Health care Industry Adapts to ACA
April 05, 2016
It is no secret the health care industry has been experiencing an unprecedented tidal wave of consolidation over the past several years. On its surface, the health care industry appears to be generally profitable, with massive mergers creating powerful integrated providers designed to capitalize on the current regulatory and reimbursement environment. But this merger activity can often disguise powerful undercurrents of financial distress.
According to the Polsinelli/TrBk Healthcare Services Distress Research Index, health care distress was on the rise in 2015. The index reviews bankruptcy filings for entities with more than $1 million in assets that self-designate as “health care” entities under Chapters 9, 11, or 15 of the U.S. Bankruptcy Code. Compared with the benchmark period of the fourth quarter of 2010, the health care index is up by almost 22 percent, indicating increasing distress in the sector.
There are several reasons for the increased distress in the health care industry. The effects of the Patient Protection and Affordable Care Act (ACA) on the health care industry are massive and are still evolving. In 2015, approximately 12.9 percent of the U.S. adult population was uninsured, a significant reduction from 2010, when 16.4 percent of the population did not have private health insurance.
Despite the contentious political environment, it appears the ACA is here to stay. Although even its most ardent supporters will concede that the ACA is not a perfect solution, the law is continually evolving to respond to various legal, political, and market challenges. From an economic perspective, the winners and losers of ACA are still shaking out, but the impact on nearly all of the major stakeholders in the health care industry is undeniable.
The insurance industry appears to be one of the initial winners. The ACA established requirements for medical loss ratios requiring that a minimum of 80 percent of collected premiums be spent on reimbursement. To offset the risk of reduced profit, the insurance industry is consolidating, reducing overhead, and gaining negotiating leverage with service providers. The “Big Five” for-profit health insurance companies—UnitedHealthcare, Anthem, Aetna, Cigna, and Humana—will soon become the “Big Three,” subject to Federal Trade Commission (FTC) approval, with the recent merger announcements of Anthem/Cigna and also Aetna/Humana.
The Big Three will represent about one-third of U.S. market share. Adding those covered by the Kaiser Foundation, the largest privately administered healthcare organization, to the Big Three’s total would bring the market share nationally to more than 40 percent. Although for-profit health insurance companies continue to expand, nearly one-half of all state insurance marketplace exchanges are distressed, and the temporary risk corridor program, the ACA stabilization program to protect insurers from adverse risk selection, is underfunded by almost 90 percent. This impending distress will likely result in failing exchanges being rolled into a larger federal insurance exchange or will require further expansion of Medicaid.
The pharmaceutical industry was relatively untouched by the ACA, which included excise taxes and incentives for generic drugs, but did not provide the exchanges with the ability to negotiate drug prices. Overall, the pharmaceutical industry has profited from the expanded insured pool, which has given more patients access to prescription drugs. Unlike other industry players, the merger trends in pharma are currently being driven by tax inversion benefits rather than the ACA.
Physicians, Physician Groups.
Physicians and physician groups have felt embattled through ACA development and implementation. For example, the ACA abolished the Stark Law’s “whole hospital exception,” which means the construction or expansion of physician-owned hospitals within the Medicare/Medicaid program is now prohibited. The regulatory burdens and the shift to value-based health care using bundled payments and accountable care-type contracts require significant investments in infrastructure and access to broader provider networks. There is a rapid shift toward very large-scale provider networks, whether as independent physician groups or under hospital banners. Between 2012 and 2014, hospital-employed primary care physicians doubled from 10 percent of staff to 20 percent. At the same time, the number of single-specialty physician practices declined by more than 40 percent. This trend will likely accelerate over the next five years.
Hospitals are at the intersection of all of the trends in the health care marketplace. As organizations move toward population health care, hospitals are being driven to build broader outpatient and ambulatory networks, creating “hub and spoke” systems. Success will be driven by keeping referrals in-system and minimizing leakage of high reimbursement procedures. Health system consolidation at the national and super-regional levels allows for larger scale, negotiating leverage with insurers and suppliers, and broader service offerings, offsetting reimbursement risk while gaining operating efficiencies.
“Owned physicians” or exclusive partnering with large physician groups is becoming a necessity. This physician alignment and coordination allows for joint negotiation of reimbursement rates and improved control, coordination, and deployment of hospital resources. Such benefits will have a cascading effect of improved computerized physician order entry (CPOE) compliance, bill coding, and patient staffing. Large health systems are creating “centers of excellence,” eliminating duplicative network services while enhancing reputational offerings and quality.
Health care system mergers have significantly increased. In the five years prior to ACA, there were 50 to 60 transactions per year. Post-ACA, transactions per year have almost doubled to 90 to 100. Furthermore the transaction size has significantly increased. Large national players, such as HCA, Ascension, and Community Health, are adding billions of dollars of revenue per year with bolt-on transactions. In addition, regional players are merging to create dominant local players within states and across adjacent state lines. In many states, the majority of health system care will be provided by two to five entities in the near future.
Although mergers bring significant cost-reduction opportunities, they also create the possibility of monopolistic increases in pricing. The FTC is increasingly concerned with the merger frenzy the ACA has created at all levels. The FTC has successfully contested three hospital merger proceedings and blocked a recent physician group acquisition by a health system. That being said, the FTC has challenged less than 1 percent of hospital transactions in recent years, and the overall trend is expected to continue.
Struggling hospitals and small health systems are rapidly seeking lifelines. Nonprofit safety net hospitals and for-profit physician-owned hospitals appear most at risk. Those with a viable balance sheet with short-term turnaround prospects (by leveraging scale, physician networks, and information technology (IT) systems of acquirers) are being absorbed by larger systems in out-of-court transactions. Those in greater degrees of distress are being acquired through the bankruptcy sale process.
During the two-year period from 2012 to 2013, 20 hospitals filed for Chapter 11 bankruptcy protection or announced plans to close. Approximately 20 hospitals filed for protection in 2014, 11 in 2015, and 10 in the first few months of 2016. Often the acquirers are opportunistic for-profit players such as Tenet Healthcare, Prospect Medical Holdings, or Prime Healthcare Services. In prior economic cycles, hospital acquisitions with stand-alone out-of-network reimbursement models have been viewed skeptically, but current buyers are building integrated health systems with robust platforms. These buyers are often championed by local communities where the alternative could be closure of the local service provider.
Retail Health Clinics.
Another key factor creating distress is the increase in alternative sources to access health care. Retail health clinics are expected to number more than 2,800, reaching capacity for 9 million more patients by the end of 2017. The expansion of “telehealth” and urgent care clinics is driving down prices and creating additional stress for health care providers.
Changes in Reimbursement.
The announcement in 2015 by the Department of Health and Human Services (HHS) that it would fundamentally reform how it pays providers for treating Medicare patients in the coming years was a seismic shift in U.S. health care policy. The intent is to reduce the volume of unnecessary procedures while improving patient outcomes. For the fifth time, the U.S. health care system in 2014 ranked last in quality compared to 10 other industrialized Western nations.5 It continues to be difficult to explain how and why performance and patient outcomes continued to be so underwhelming, even as U.S. health expenditures per capita ranked highest among the countries studied.
To improve outcomes, the Centers for Medicare & Medicaid Services (CMS) will tie 30 percent of all fee-for-service (FFS) payments to providers to quality initiatives through alternative payment models—particularly accountable care organizations (ACOs) and bundled payments—by 2016. This standard will rise to 50 percent by 2018. Another key goal for HHS is for virtually all Medicare FFS payments to be tied to quality and value; at least 85 percent in 2016 and 90 percent in 2018.
With alternative payment models, providers are now accountable for the quality and cost of care for the individual patients and populations of patients they serve. How systems respond to this broader definition is increasingly critical under the ACA. It strongly encourages health care delivery systems, public health agencies, and community-based organizations to work together to improve health outcomes in the communities they serve. Population health dispenses with the old model that said, “The more you do, the more you get paid.”
All indicators point to the health care industry's transition away from the traditional FFS model going much slower than expected. Many entities are taking a wait-and-see approach and evaluating how other participants in markets perform before fully engaging.
A Proactive Approach
The turmoil and distress in the health care market is providing competitive advantages to proactive strategic and financial players. To capitalize on the existing market forces, providers should:
- Develop and implement an ambulatory or retail care strategy. The continued evolution of how consumers want to be engaged is driving the rapid growth in this area. Consumers are demanding convenient and affordable basic health care.
- Develop a population health management model that that will generate sustainable results coupled with savings initiatives and quality improvement efforts. Physicians and nurses must be engaged in the process to obtain buy-in from critical physician networks seeking a partner. The pioneers in population health management will have significantly more time to adjust and learn to help capture critical market share to bolster their negotiation positions. They will be the participants sitting at the table framing the reimbursement criterion. Most importantly, truly managing populations requires a substantial market share or well-defined partnerships or alliances.
- Swallow the tough pill and immediately begin the process of transitioning to alternative payment models. Current economic conditions are frothy but positive, but lower reimbursement levels are the future. Being prepared for what is to come is critical.
- Consider affiliations or partnerships as part of growth and cost reduction strategies, short of full mergers and acquisitions. Many hospitals that were former competitors joined forces without full mergers in 2015, in part to avoid FTC scrutiny. Organizations are moving to redefine themselves in the era of value-based performance, allowing them to retain their leadership teams and governing boards, but increasing patient access to services and the ability for the facilities to better coordinate care.
The failure to proactively respond to the evolving health care market will almost certainly turn a health care entity into an acquisition target through a distressed acquisition or bankruptcy sale. The only way to survive in 2016 and beyond is to address underlying health care distress in a practical manner.