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Non-Profit Hospitals Taking More Aggressive Stance Toward M&A, But Deals Aren't Always Easy

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Hospitals, health systems and physician's practices are forming partnerships at an accelerated rate, almost as if they were going out of style. For-profit systems are not the only movers and shakers in the merger and acquisition market. While for-profit systems have recently gained a lot of attention for their aggressive acquisition strategies, non-profits are remaining active. Certain strong non-profit systems are actively acquiring other hospitals, while smaller systems and hospitals are merging with physician practices at a growing rate.

Denver-based non-profit Catholic Health Initiatives is currently engaged in a potential merger with the Louisville (Ky.) University Hospital, and non-profit Provena Health in Mokena, Ill., recently signed a deal to merge with Chicago-based Resurrection Health Care. Novi, Mich.-based Trinity Health has also been active in merging hospitals in western Michigan, and Duke University Health System in Durham, N.C., partnered with LifePoint Hospitals, a for-profit hospital manager based in Nashville, Tenn., to buy and run community hospitals in North Carolina.

So why the influx? And are non-profit hospitals expected to stay active amidst dwindling funds? The Patient Protection and Affordable Care Act has certainly been a driver of the recent trend as health systems look to work collaboratively to offer quality patient care, but a non-profit hospital's access to capital — and scarcity of capital — are also propelling the robust M&A market forward.

Impact of healthcare reform
When PPACA was signed into law on March 23, 2010, the government looked at the healthcare system and how it could reduce overall costs and improve quality care for patients. The solvency of the Medicare and Medicaid systems coupled with the PPACA have led to one certainty that is already taking place: Reimbursements, both private and public, are decreasing for providers, and providers must now find ways to offset those reductions while entering into a 21st century healthcare system surrounded by technological upgrades and preventive patient care.

So for non-profit hospitals — which include academic medical centers, religious systems, community hospitals and hospital districts — this means finding ways to help bear new costs and cuts with limited capital, and many are looking to affiliate with other systems and physician's practices. Steven Bjelich, president and CEO of non-profit Saint Francis Medical Center in Cape Girardeau, Mo., says the healthcare reform impacts all parties in all regions, and it has led his hospital to employ 117 physicians in various specialties to both help the physicians as well as his hospital. "Bringing physicians and their practices on board helps to stabilize our referral base and to ensure patients have access to quality care regardless of their payor source," he says. "Under the incentives created by healthcare reform, it is imperative to become a physician-led and physician-driven organization."

The acquirers and the acquired
If a non-profit hospital is acquiring another hospital, like CHI's proposal, that hospital is most likely a "strong player," says Bart Walker, JD, partner at McGuireWoods. While the biggest non-profit systems and the mid-size systems have the capital to pursue the purchase of another hospital, small non-profits simply don't have that ability. Instead, they are looking at affiliating with physician's practices.

Nolan Newman, CPA, founder of Newman Dierst Hales, a Seattle-based accounting firm that serves healthcare providers adds that hospitals that do the acquiring depends on the size of the hospital, the hospital's borrowing capacity and the overall scarcity of capital in the market.

Physician groups, overall, are the largest source of growth in the healthcare M&A market. Physician practice merger activity has increased 200 percent from the second quarter of 2010 to the second quarter of 2011, according to a report from Irving Levin Associates, and that's where non-profit hospitals can stay in the game to meet the demands of healthcare reform while expanding their business opportunities. "Small hospitals don't have the wherewithal to buy another hospital," Mr. Walker says. "But they have been more active and more open to joint ventures with doctors and acquiring ancillary services. In the end, I think all of the hospitals are looking for ways to grow."

That is exactly the field where Mr. Bjelich has expanded Saint Francis. The Medical Group Management Association found 65 percent of established physicians and 49 percent of physicians hired out of residencies or fellowships were placed in hospital-owned practices in 2009 due to higher starting compensation. "Physicians coming out of residencies are seeking employment with hospitals to assist in relieving the huge expense of medical school," Mr. Bjelich says.

Benefits and other considerations
Mr. Walker says there is one clear motive why non-profit hospitals are staying active in the M&A market: payor reimbursement contracts. "One of the big reasons [to merge and acquire] is to have greater negotiating power with payors," Mr. Walker says. "The smaller providers are being squeezed by payors, and it's tougher to get better rates."

"A lot of reimbursement rates have gone down for physicians and private practices, and they are looking to hospitals to get more leverage to negotiate payor contracts," adds Milton Cerny, JD, counsel at McGuireWoods.

Purchasing electronic health record systems has also been both a goal and benefit for some non-profits merging. For example, a 200-bed community hospital and a 2,000-bed hospital system may need to buy and implement EHRs. "The 2,000-bed system is going to have a financial advantage because it can spread the cost and overhead over more units," Mr. Newman says. "And it probably has better borrowing capacity than a smaller hospital." For some smaller hospitals, affiliations and mergers may be the answer to control those types of large, EHR-based capital projects.

The same applies to physician's practices. An individual physician within a practice can spend up to $10,000 on EHRs initially, and there are also the annual hardware and software maintenance costs, Mr. Bjelich says. Physicians practices who are unable to front all EHR costs, like some small hospitals, also turn to bigger health systems to make the transition easier. "Because of the resource of extra staff, hospitals and health systems have an advantage over private physician offices to make that conversion with less downtime," Mr. Bjelich says.

Rural non-profit hospitals are in a particular bind, though. Mr. Newman says they may not have the size or scale to support massive capital projects such as EHRs on their own. Additionally, there may not be as many interested systems that want to merge with those rural hospitals due to their remote location and sparse patient base. While there have been some rural affiliation transactions, they are not as prevalent.

Payor reimbursement and technology upgrades are some of the benefits of acquiring another hospital or practice, but non-profit hospitals still must keep certain items in mind. As non-profit hospitals undergo these transactions, Mr. Cerny says the number one goal is to protect the tax-exempt status, but hospitals must also be mindful of the unrelated business income (i.e., Is a hospital regularly generating income that is not related to its exempt purpose or mission?), be able to submit clear reports to the Internal Revenue Service and be able to conduct community benefit analyses to show their value within the community.

"Attorneys structuring these transactions have to be careful advising hospital systems," Mr. Cerny says. "Always apply fair market value of standards and a policy of rigorous due diligence policy. Closely examine these transactions to make sure there are no potential hidden costs. It is important that senior management understands that the acquisition of a new physician practice will affect the management structure of the hospital organization."

Religious institutions must also be mindful of several factors. For example, the potential merger between CHI's Catholic-based hospitals and Louisville's University Hospital has drawn a lot of criticism and governmental scrutiny because it has not been made clear if the taxpayer-supported University Hospital would adopt Catholic ideals on reproductive care, end-of-life patient care, tubal ligations and other issues. Mergers between religious systems and publicly funded systems walk a fine line between the separation of church and state. If matters such as those in the CHI-University Hospital case are not covered upfront, deals could hit a huge snag or not be approved at all.

Non-profit hospitals, M&A and the future
Hospital acquisitions of physician practices, however, do not seem to be dying down anytime soon. "In my opinion, the number of non-profit hospitals acquiring practices will continue to grow," Mr. Bjelich says. "I see the need for hospitals to transition away from the constraints of the traditional voluntary medical staff toward committed physicians who will partner with them and join their priorities around more standardized measures of quality performance, patient safety, efficiency and patient satisfaction."

Mr. Walker agrees that the current healthcare reform and flailing economic climate will lead to more non-profit hospitals merging, be it with another hospital or several physicians' clinics. "I think the trend is toward greater consolidation," he says. "Capital is relatively cheap right now, and they can issue bonds at a relatively attractive rate.

Whatever non-profit hospitals do, though, the executive team must know all ramifications before they finalize a merger, affiliation or partnership. Payor reimbursement contracts, refinancing of new debt and increased management of more moving parts will all surface. "From a leadership standpoint, have a management team that is very clear about its strategy to affiliate or remain independent, and there also needs to be clarity of strategy at the board level," Mr. Newman says.

Related Articles on Non-Profit Hospital Acquisitions:

6 Legal Topics to Consider Before a Hospital Completes a Merger
Archbishop Calls for Participants in Kentucky Merger to Follow Catholic Rules
7 Points on How Hospital Acquisition Strategies Have Changed

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