Is Bigger Better?
With a doctorate in public health and master of business administration, over the last 10 years Rob Edwards has served in leadership roles in health policy and corporate development for a large health system, leading asset acquisition opportunities and joint ventures as well as developing networks to create access to specialty services for patients. Before that, he was appointed by the governor of Kentucky and secretary of health to various positions to help support modernization efforts in Medicaid, behavioral health and public health. We sat down to discuss M&A from the hospital perspective. —Editor
First and foremost the thing to remember is, in order to heal patients in the most appropriate environments, hospitals are incredibly capital intensive. And the amount of dollars that it takes to be competitive in the inpatient business and the fact that we’re such a workforce-dependent industry, the perception might not always meet reality when it comes to hospital consolidation.
When hospitals get together, it is most of the time driven by the fact that we need bigger and bigger balance sheets to support the ongoing investment in technology and age of plant to make us competitive with consumers and the clinicians we must recruit to provide care. And then the other piece is that hospitals—the inpatient business—are not very profitable. People see these big buildings and a lot of capital being spent, but most hospitals have a low-single-digit margin for their hospital beds. So the only way sometimes to grow is by merging or looking for merger partners of some kind. Some health systems, like UK HealthCare, have pursued a model of collaborating on service lines across broad geographies—such as cardiovascular care or oncology—which is a less capital-intensive model.
There has been a tremendous amount of research done that has looked at whether you can find scale or if scale helps drive down cost. While the evidence is a little bit mixed, I think there are really good peer-reviewed articles out there that say if hospitals merge you can find synergies in cost. You could also rationalize healthcare services a little bit so you don’t have duplication of very high-cost inpatient services. That is where good public policy matches good strategy. Then the question is, what is the effect of consolidation on price? Think about who our biggest payer is. Our biggest payer is Medicare, now, I think almost everywhere, followed by Medicaid. And there’s very little price variability in Medicare. There’s geographic variability, but Medicare is going to, in general, pay at the same rate regardless of if you’re consolidated or not.
So it does then come down to the commercial insurance space or the self-funded space. And there’s no doubt we need a lot more research to happen right there about the effect of consolidation, specifically on self-insured and fully commercially insured contracts. I used to talk about how the fact that, because we’re so heavily regulated, maybe the markets don’t work perfectly and it’s hard to disrupt healthcare. There’s no doubt that there’s more disruption than ever and the traditional margin making activities at hospital systems are being encroached upon by disruptors.
My short answer is no. I think those data show there was a lot of consolidation the several years following the ACA. I think true value-based contracting between hospitals and payers of any kind has been slow to move, but frankly that may be different based on what part of the country the hospital is in. So this idea that we need to have huge IT systems in place and clinically integrated networks in order to manage a population of 8 to 10 million people, it just hasn’t played out like that. And so I don’t think that transactions are being driven by value-based medicine. I think they’re still being driven by the need for access to capital and the opportunity to reduce costs and rationalize expensive healthcare services. There are opinions out there that say the idea of more value-based payment models, more risk-taking payment models, is driving healthcare payers to want to control more of that risk/reward factor. Do you think that falls along the same lines of just not really bearing out yet?
If you look at the transactions that have been happening on the payer side, it has really shifted from trying to increase your risk pool so you have less risk and you’re able to reinsure it better—those types of mergers from an account standpoint have decreased. But the way PBMs and insurers and frontline healthcare providers have merged with payers, I think, is much more indicative of how we might create new ways or reuse old ideas regarding managing the cost equation a little bit better if payers have the ability to directly manage care at the consumer level. When you look at these huge national pharmacy companies all looking at deals with the payers, that’s mutually a benefit. We get so much scale on the PBM side, but we also, from the payers’ perspective, have feet on the front line that we can direct our consumers to in pharmacies for very low-cost care.
I really think the hospital industry has proven over and over again that having hospital- based health plans is not a successful strategy for hospital systems. And we can now point to some really big-time failures in provider-based plans as qualitative feedback that hospitals can’t build up a risk pool big enough to really compete against the Anthems or Uniteds of the world.
Now, on the other hand, United, Humana, Anthem are all starting to make acquisitions that help them be more vertically integrated, and I think, if you approach that from the standpoint of trying to reduce your risk of urgent-care costs and ancillary costs like imaging, outpatient surgical costs, it’s actually a pretty smart approach if you’ve got the population base in the same geography that matches up.
I don’t think we will. I think we’re so subject to changes in the regulatory environment that it is a constant state of change with one asterisk: hospitals are extremely capital intensive and for now extremely workforce dependent. Because of that, a lot of disruptors will be scared off from getting into the hospital inpatient business. And the purpose that a lot of the larger tertiary, quaternary hospitals provide, this very high-acuity ICU care, where we have programs like pediatric solid organ transplantation, bone marrow transplant, ECMO [extracorporeal membrane oxygenation] programs, clinical trials in oncology, you need huge scale to be able to deploy those types of resources. I think that space will be very difficult to disrupt. While there’ll be some consolidation there, at some point your ability to grow scale is not as helpful from a margin-making standpoint as the first couple of those are. That’s really for the kind of classic, large, urban teaching or semi-teaching hospitals.
I think the community hospital space, where there are national players and for-profit players, will continue to grow and the disruption will be people exchanging hospital portfolios just like other industries, including insurance, do. Then the small, rural hospitals are going to be the place where, if want to protect them, we have to have true regulatory protection in place to keep them going. But I think it will continue to unfold as an interesting space to watch from an M&A standpoint. All it takes is a small regulatory change at the federal level or a small regulatory change at the state level to completely reshape the traditional hospital industry, because our margins are so small and we’re so sensitive to changes with the government payers.
Edwards is chief external affairs officer at University of Kentucky HealthCare. The views expressed here are his own. email@example.com