Limits on Age Differentials Will Penalize Young

Good article in Washington Post yesterday pointing out that the health care reform bill’s restriction on age based premium can only vary by a factor of 3 means that young insured adults will be subsidizing older insured adults.  This change has the largest impact on young adult males ; they have low costs actuarially, so in the past were able to purchase very inexpensive insurance (as long as they had no preexisting illness).

There is no free lunch. Restricting the ratio between the highest and lowest health care premium is great for those on the upper end – but this ‘compression’ of rates means higher rates for those at the lowest risk.  In the end, we have to manage the total costs we incur – just shifting costs from one group to another is painful, and threatens to be a “wedge” issue to make health care reform less popular.  

Potential Cerberus Exit Strategies After Caritas Investment

In my last post, I reviewed ways that the Cerberus private equity takeover of Caritas Christi Health Care System could, but likely would not, lower overall health care costs in Massachusetts.

What are Cerberus’ potential exit strategies?

1)     1. No Exit. 
Hospitals have serious cash flows, and if the new Caritas can make money, this could be a good business to be in.   Further, expect Cerberus to assess management fees upon Caritas which will be a recurrent source of revenue.  However, venture capital firms seek high rates of return, and hospitals almost never would meet a venture funds “hurtle” rate.  Therefore, I believe long-term full ownership seems unlikely. Continued Cerberus ownership would require profits for eventual distribution to the investor – and historically Caritas has had margins of under 1%.  A private owner would not likely tolerate such a low rate of return.

2)      2. Buy Low and Sell High
Hospitals could be undervalued now due to uncertainty surrounding health care reform.   Having fewer uninsured in the post-health-care-reform environment should be good for hospitals, so perhaps their value will be increased in the future even absent huge improvements in Caritas’ value proposition. On the other hand, there is real worry that the Senate bill just passed will still leave more uninsured than was hoped. Some of the subsidies will be funded through lower fee updates in the Medicare program over the next ten years, which will place additional financial pressure on hospitals. If Cerberus sought to sell Caritas and other acquired health care facilities, there would be large pressure to show very high margins in the quarters immediately prior to the sale.

3)    3. Dividend
Both HCA and Vanguard Health Systems just paid their venture capital owners enormous dividends (in the case of HCA, a total of $1.75 billion) over the last year.  They accomplished this by taking out large amounts of debt.    Essentially, these private equity owned systems recently took on just the kind of debt which Cerberus is pledging to wipe off Caritas’ book. Such a dividend payment would leave the new organization in much the capital-starved position it finds itself in now.    

4)      3. Selective Health Care Asset Sale
Some of the Caritas facilities are financially successful on their own, and could be attractive to other for-profit owners.  After the three year period, the organization could sell Norwood Hospital, for instance.  It could not likely sell Carney Hospital, a perennial money-loser in a relatively poor neighborhood with a predominately disadvantaged population.   Selective health care asset sale would likely be a prelude to eliminating money-losing programs and facilities.

5)      3. Selective Sale of Non-Health Care Assets
In some cases, Caritas’ real estate alone might have substantial value. This was the case with the K-Mart-Sears merger, where the value of the real estate exceeded the ongoing value of the retail chains.  Waltham Hospital was kept on life support briefly by a developer – who eventually secured the property for mixed use development.  It’s possible that selective non-health care asset sale could provide resources to maintain social mission and maintain money-losing programs, which could provide social value.  Cerberus could approach this more dispassionately than a nonprofit management.

One way or another, whether Cerberus maintains ownership or transfers ownership to another party after the three year period has ended, the Caritas system will have to increase its earnings to cover

•    Local and other taxes from which nonprofit Caritas is now exempt
•  Loss of philanthropic donations
•  Additional layer of management
•  Payments to investors recognizing the time-value and the risk of Cerberus' investment.

That’s why it’s likely that over the long run health care costs will likely be higher as a result of this investment, despite the recent coverage suggesting otherwise. 

Link: Part One (Ways Acquisition Could Save Dollars)
Link: Part Two (Ways Hospitals Can Improve Profitability)

How Can Caritas Increase Its Profit (And How Will It Likely Increase Its Profit?)

In yesterday’s post, I reviewed the proposed transaction whereby a private equity firm would acquire Caritas Christi HealthCare System in Massachusetts.  Today, I’ll discuss approaches to improve profitability at any health care facility. Tomorrow, I’ll examine some potential exit strategies for Cerberus Capital, which proposes to acquire Caritas.


By the way, yesterday's Boston Globe had another article accepting the premise that the Caritas acquisition would lead to overall health system cost savings.  

All the benevolent talk of lower overall costs notwithstanding, successful delivery systems have to make money, whether they are for-profit or nonprofit.  Without a bottom line, hospitals can’t make investments in new technology, can’t offer the amenities patients demand, and often can’t even keep up with plant depreciation.  So – profit margin is absolutely necessary – for nonprofits OR for for-profts.

There are two ways for health care systems to improve their profit margin:

1.    Decrease costs

a.     Decrease labor cost through substituting less expensive labor (non-union for union employees; physician assistants for physicians)

b.    Eliminate or downsize programs with negative margin.  

c.     Eliminate or scale back money-losing facilities

d.    Fail to make new capital investments

2.    Increase revenue

a.     Increase number of patients seen

b.    Do more procedures on the patients already in the system

c.     Offer a mix of higher margin services

d.    Demand higher unit prices at the negotiating table

e.    Improve rates of collection

f.     Dissuade patients with “poorly paying” insurance from coming to your facility (and use this capacity for patients with “better paying:” insurance.

Decreasing the input costs of health care is the best way to drive increased margin.  Hospitals which figure out how to offer equally good (or better) health care with fewer resource inputs SHOULD gain a competitive advantage.   Increasing efficiency in any business is good – because it increases the overall value delivered to the customer.

However, in health care (and many other fields), it’s a lot more attractive to increase revenue than to decrease costs. Further, through multi-year labor contracts and commitments not to cut back on existing services and facilities --  Caritas has fixed many of its costs over the first years of this new arrangement.  So, to be profitable the system will need to increase revenue.  Many of de la Torre’s changes at Caritas have tilted toward increased revenue capture, including increasing cardiac surgery, use of robotic surgery, and investment in high cost imaging equipment (that once in place tends to be highly utilized.)  Even the new construction at Good Samaritan which will embed a CT scan in the emergency department will clearly raise overall collections for Caritas (thus increasing health care costs.)   Capital will largely be deployed where businesses like to deploy capital – where it will lead to surging revenue.

Increased revenue for the new Caritas system either means that overall health care costs climb further, or that other health care systems will see lower revenue.  Lower revenue is a terrible hardship for hospital systems, which have high fixed costs and therefore must make deep cuts if they suffer relatively small revenue declines.  Some have suggested that an invigorated Caritas will put more downward pressure on prices at the big Boston teaching hospitals. I believe that an invigorated Caritas will make strategic investments that will lead to higher revenue – some of this would be new revenue altogether, which raises overall costs.  Therefore, I’m skeptical that the new ownership is likely to lead to a diminution in the rate of health care inflation.

On the positive side, Caritas has engaged in a number of global payment (capitation-like) contracts - and these are payment methods where lower resource inputs lead to financial success.

In my next post, I’ll discuss Cerberus’ potential exit strategies, and implications for managing health care costs. 

Link: Previous Post

Why Acquisition of Caritas Christi HealthCare System is Not Likely To Lower Overall Health Care Costs

(Part One of Three)

I thought my first post back from vacation would be about the passage of health care reform – but the news from Boston that Caritas Christi, a six-hospital system which has been owned by the Catholic Archdiocese of Boston announced that it intended to sell itself to Cerberus Capital Management.  Many commentators have weighed in on the possibility that this would increase provider competition in the greater Boston area, and that the investment from Cerberus would lower overall health care costs.  The initial Boston Globe article  even said that the acquisition would “turn what had been debt and pension payments into cash flow.” The Globe editorialized in favor of the move, although with a small amount of caution.

In today’s post, I’ll examine the transaction, and hypotheses for how this would lower overall health care costs. The second post will concentrate on how hospital systems make money, and the final post will examine different ways Cerberus could benefit from its investment in Caritas Christi over time.

First, the transaction itself:

Cerberus will put up $830 million, which will allow the system to retire its debt, fund its pension plan, and make some investments and repairs to make Caritas hospitals more attractive to patients.   In exchange, Cerberus will gain ownership of the capital assets of Caritas Christi, which it says it wants to make the nidus for acquiring additional hospitals across the country.    Cerberus has pledged to honor existing labor contracts, continue existing programs, and maintain existing facilities for at least three years, during which time it will not receive any return on its investment (although presumably will be able to pay itself management fees).  The facilities will continue to honor Catholic precepts, and not offer full reproductive services.  As for-profits, the facilities will pay local property taxes (worth $7 million per year to Boston alone according to Mayor Tom Menino.) After the three year period, Cerberus will no longer be obligated to maintain programs, and would be free to ‘cash out’ of its investment.

Ralph de la Torre is quoted as saying “We are committed to being a regional, community-based system that lowers costs.’’  

How could this sale to Cerberus lower costs?

1. Substitution of capital for labor
Cerberus’ new dollars could mean that the system could make investments that would allow it to lower the resource cost of medical care in the future.  However, Caritas’ labor costs are fixed through the end of a four year set of union contracts, so the labor savings will at best be minimal.  Therefore, I conclude that it’s not likely that this new capital influx will lead to lower labor costs at Caritas.

2. Use of capital to decrease other input costs
de la Torre specifically notes that capital to deploy electronic medical records can decrease duplication of services.  That’s true – and much remarked upon – but the marginal costs of duplicated services are quite low, and there is an emerging consensus that EMRs make health care better, but don’t really decrease costs a lot.

3.    Better management
Private equity firms often pick up underperforming companies and impose new, highly disciplined management.   In this case, Cerberus says it will maintain the current leadership team, which has been credited with turning Caritas around.  If there is no change, this is not one of the ways the Cerberus investment will lower overall health care costs.

4.    Make Caritas’ facilities more attractive to patients who would otherwise go to more expensive facilities This is the “we’ll take the business from Partners” argument. The Attorney General’s recent report shows huge cost differentials from high cost to low cost providers, without substantial quality differences.  That report confirms that Caritas is a relative low-cost provider.  If patients choose St Elizabeth’s over Mass General in light of these new investments, costs are likely to be lower.  However, if Caritas Norwood Hospital takes business from nearby Milton Hospital (instead of more expensive South Shore or Brigham and Womens), costs for the overall system will instead rise.

My conclusion is that it’s wildly optimistic to suggest that this capital influx will lead to overall cost savings in Massachusetts.  Undercapitalized hospitals generally have lower costs, while well-capitalized hospitals generally have higher costs.  However, it will be very difficult to turn the application down, as an underfunded Caritas clearly cannot compete against the other health care delivery systems, and the system is an important safety net provider and an important source of jobs in many communities.

Next Post: Improving hospital profitability