The Perfect Storm: Health Reform and America’s Hospitals

Clinic Construction

When the Cleveland Clinic announced job and expense reductions of 6% in 2013, the healthcare sector took notice.

Did the world-renowned hospital and healthcare research center, with 40,000 employees and a $6 billion budget, really believe it did not possess the heft to take on the increasingly turbulent sea changes in American healthcare? Or was this yet another stakeholder using Obamacare as cover to drive draconian change?

Both sides of the political aisle were quick to make hay of the announcement, with conservatives blaming reform for eliminating jobs while liberals questioned the timing of the cuts when the Cleveland Clinic was posting positive growth. The answer from Eileen Sheil, corporate communications director, was apolitically straightforward: “We know we are going to be reimbursed less.” Period.

The question of reimbursement reform and the unintended consequences of the Affordable Care Act are weighing on the minds of hospital executives nationwide as independent, regional and national healthcare systems grapple with a post-reform marketplace. The inevitable conclusion that the unsustainable trend in American healthcare consumption is now at its nadir seems to have finally hit home.

These days, America’s hospitals are scrambling to anticipate and organize around several unanswered questions:

  • How adversely will Medicaid and Medicare reimbursement cuts affect us over the next five years?
  • Can we continue to maintain our brand and the perception that any employer’s PPO network would be incomplete without our participation?
  • Can we become a risk-bearing institution?
  • Can we survive if we choose not to become an accountable care organization (ACO)?
  • Will the ACO model, by definition, cannibalize our traditional inpatient revenues?
  • Can we finance and service a hard turn into integrated healthcare by acquiring physician and specialty practices?

Go It Alone or Join a Convoy?

Mergers and acquisitions remain in high gear in the hospital industry—“the frothiest market we have seen in a decade,” according to one Wall Street analyst. “Doing nothing is tantamount to signing your own death certificate.”

Many insiders believe consolidation and price deflation is inevitable in healthcare. Consolidation, however, means scarcity of competition. If we operate under the assumption that scarcity drives costs higher, we may not necessarily feel good about consolidation leading to lower costs unless mergers are accompanied by expense cuts that seek to improve processes, eliminate redundancies and transform into a sleeker, more profitable version of one’s former self.

Bigger may not always be better, but bigger seems to have benefited a select group for the last decade.

The U.S. healthcare delivery system has been a primordial landscape where larger, geographically dominant systems command larger fees for service reimbursements while smaller, unaffiliated facilities are eventually trampled by insurers and systems fighting over unit cost.

Most hospitals struggling to operate off rationed Medicare and Medicaid reimbursements have had no recourse but to shift costs where they could to commercial insurance to create some financial ballast.

Larger, geographically exclusive systems were added by the tailwinds of the backlash against managed care and overly restrictive HMOs. Aggressive care and access oversight were replaced with care coordination and kinder, gentler open access PPOs. Insurer reimbursement invariably favored larger systems that broad PPO systems considered too essential to exclude.

Further down the healthcare food chain, smaller, independent hospitals, specialists and primary care providers experienced steeper cuts in reimbursement, precipitating insolvencies, fire sales, retirements and sales of private practices. With lower-unit-cost hospitals and providers disappearing, employers found themselves grumbling about the rising costs of care—a trend they helped enable.

Macro and Micro Climate Change 

In the past, hospitals had the ability to tack and veer into headwinds created by shifts in the economy and consumption of services. Cost shifting from public to private, the delay of cuts to Medicare and Medicaid, aggressive management of inpatient services favoring higher margin ambulatory services, opaque pricing and employer appetites for broad, open access PPO networks—all these tempered the effects of market pressure on a hospital’s unit cost. Effectively managed hospitals, both for-profit and nonprofit, managed to survive in an environment of unaligned incentives by recognizing consumption and reimbursement trends and by getting creative.

In a recent blog post, “Can Hospitals Survive? Part II,” industry analyst Jeff Goldsmith writes that, from 1980 to 2010, U.S. hospital inpatient consumption fell more than 30% despite a population growth of 90 million people. During the same period, Goldsmith writes: “[H]ospitals’ ambulatory services volume more than tripled, more than offsetting the inpatient losses; the hospital industry’s total revenues grew almost tenfold.”

Goldsmith points out that the United States historically has consumed fewer per capita inpatient days than other countries. But shifting consumption and volume delivery to ambulatory services has ensured costs will continue to climb.

A 2008 McKinsey study found two thirds of the overspending gap between the United States and other Western countries could be traced to overtreatment and overcharging for ambulatory and prescription drugs. As the economy slowed and employers chose to shift more cost to consumers, consumption slowed to its lowest level in a decade, creating pressure and accelerating the demise of many hospitals.

In 2014, the need for transformation is running headlong into entrenched interests and limited thinking. Slow-to-move boards of directors handicap many hospitals, which also must deal with uncertain public policy, lesser access to capital and the rise of disruptive boutique competitors, such as concierge-based radiology management. Add into the radioactive mélange a dose of organized labor, shape-shifting commercial and federal reimbursement practices, managed care, competitor consolidation, unreimbursed care and the perpetual drumbeat to embrace new technologies, and it’s a wonder any hospital system survives. In some cases, we have witnessed bricks-and-mortar providers sink noiselessly under the weight of their own inability to compete.

The wonderful trade winds of unmanaged fee-for-service Medicare and the “must-haves in my PPO network system” are dying down. Many mega-systems now struggle to reconfigure their cost base away from expensive tertiary and inpatient care. Trends are inexorably reversing. They are moving toward primary care oversight, outpatient and specialized ambulatory facilities and the delivery of at-risk and bundled care. As the federal government shifts to bundled Medicare reimbursement for outcomes and shifting readmissions risk, commercial insurers have been quick to follow. This creates a major tidal change from volume to value.

From Treating Symptoms to Taking Risk

Larger regional and national systems, seeking to protect the hard-fought spoils of higher negotiated fee-for-service reimbursement, are slowly awakening from the misconception that size would inoculate them from reimbursement reform. Others have had the foresight to organize as accountable care organizations. They also look at expanding their care delivery models to integrate primary and specialty care to more confidently accept and manage risk of a population. Other plans have moved to acquire competitors and create an integrated care delivery network to essentially become capable of managing patient risk.

The push toward integrated care delivery has led to a rash of mergers, acquisitions and stra

The fight is now over primary and specialty care. For some healthcare veterans, the trend is unproven and appears to be an ill-fated, back-to-the-future regression where hospitals proved unable to adequately manage risk-sharing arrangements.

Hospital 2.0

One thing is certain. We are at the end of an unsustainable trend line. The Affordable Care Act, along with an unfunded Medicare obligation of more than $50 trillion, has combined to create a perfect storm of change. Unlike the 1980s, technology may provide a path to a safe port. While modern medicine showcases the extraordinary value of medical technology, human capital is still poorly deployed. Hospital profitability remains highly variable with manual processes deterring the digital transformation that will be required. Unlike other industries, the digital age may require hospitals to effectively cannibalize their operating models to survive. It’s up to hospital CEOs to drive change in the face of entrenched labor and those who believe reform is a tempest in a teapot.

In the next decade, leadership will matter. The gap will grow between industry leaders and followers. Institutions that survive must let strategy drive structure, starting with the notion that payers are seeking demonstrably better value and accountability.

The best institutions are watching the horizon line carefully and retraining their crews to navigate inevitable payment reform. As always, technology is not a panacea but a critical navigational tool to facilitate procedural changes that will force hospitals to treat more people at home, in a primary care physician’s office and in outpatient settings.

The Consumer Age

When healthcare customers have access to additional information, they become buyers.  Buyers behave differently than customers. For one, they have less tolerance for huge variations in price and quality. Web-based information will continue to expand and be readily available to buyers, making it clear to consumers which healthcare practitioners are providing the best value.

The Consumer Age of healthcare will be accelerated by the proliferation of high-deductible plans and greater transparency. The new buyers of healthcare will be more intolerant of cost of inefficient or overpriced players. If you are too expensive, that’s you’re problem. A new loyalty calculus reduces any provider’s ability to overcharge by as little as 5% to 10%, depending on your industry and your ability to show demonstrably better value.

As ambulatory care becomes increasingly in vogue, concierge services and consumer tools will steer financially invested consumers to providers who can demonstrate equal (or better) outcomes for specific conditions. Technology will make things better, faster and cheaper. Any 2.0 version of any technology must prove by definition that it drives improved value delivery.

High-deductible plans and technology-support tools will commoditize segments of healthcare delivery where care is accessed on an elective or ambulatory basis. This will cut deeper into hospital profits. The margin of loyalty and wider variability of pricing may remain in areas such as catastrophic care, but as patients live longer with chronic conditions, payers will seek alternatives to inpatient care. The hospital that has not pivoted out of bricks and mortar into alternative forms of care—essentially cannibalizing their current inpatient models—will vanish.

There is evidence of an emerging demographic dividing line also separating customers and buyers. Those under the age of 35 have generally grown up using technology and are not as insistent on the intimacy that today’s analog healthcare seeks to deliver at a premium.

Telemedicine, home health delivery, and primary care smartphone access will routinely be embraced while older, high-utilizing populations will still cling to their highly subjective notions of access and bedside manner to judge delivery quality. Today’s hospital CEOs have to make provisions for the Millennials at the same time they are serving a reluctant and needy boomer generation. Losers will focus on only those who buy “value.” Winners will accept that payment reform has redefined value.

Hospital, Heal Thyself

Many hospitals will have a difficult time convincing third-party employers they can effectively manage third-party risk when they cannot tame the trend and consumption of their own domestic population of employees. Hospitals often employ multi-tier plan designs to encourage use of in-patient and hospital-related services. Theoretically, consumption of care within owned facilities results in lower unit costs than those incurred in non-owned facilities. However, the historical absence of integrated care delivery, concerns over privacy, limited commitment to health and wellness management, poor controls over tracking domestic consumption and an absence of case management, all have led to a double-digit medical trend for the same institutions that now claim to have achieved affordability.

Hospitals seeking to become commercial ACOs must convince employers they have first tamed their own spending and achieved first-quartile trends. This requires demonstrating how a captive population of owned employees has been transformed, with the focus shifting from delivering health services to managing population health.

Historically, employers (the real payers) have sought to maintain broad, open-access PPO plans and, in doing so, slowed the process of market-based payment reform. By insisting on including a broad roster of providers in a PPO network and then reimbursing everyone on a percentage of negotiated discounts, employers have all but ensured enormous variability in unit costs. They have so far resisted the one essential solution to payment reform—narrow networks that drive higher costs and outlier plans to modify pricing toward a more reasonable mean. While Medicare has tamed this dragon with all-payer reimbursement, private payers continue to enable unit costs that may vary as much as 500% for certain ambulatory and elective services.

The introduction of narrow network plans in public exchanges will be a litmus test for hospitals. Uninsured patients covered under narrower networks will not be concerned about less choice in exchange for better economics since they have no basis for comparing their new narrow network against an old private plan. Previously insured patients will complain that the narrower networks are inferior because of limited choice.

It remains up to private employers to develop a deaf ear toward those espousing the need for open network access. Ultimately, in larger markets like New York or Los Angeles, employees should be asked to choose among several integrated care delivery systems. This, in effect, achieves the vision of captive, narrow network care. The question remains whether these large systems will emerge as the lowest-cost providers or remain as they are today, the more expensive unit-cost provider because of their brand, size and bargaining power with insurers.

Swimming Naked

Goldsmith questions whether the current trends in hospital management will enable affordable and compassionate care. “Both the merger and practice acquisition booms are questionable long-term strategies,” Goldsmith writes. “They also come with a steep opportunity cost. As one Wall Street analyst said on CNBC last year: “It’s either make deals or run the business.” It’s pretty much impossible to do both at once, particularly as the hospital business is changing due to the insurance market and payment reforms accelerated by ACA.”

Perhaps this may all lead to a new reality show: Hospitals in ICU. The irony now is perhaps that bigger is not necessarily better and the very mindset that created the behemoth may find it hard to adjust to the next series of changes required to remain nimble and relevant.

“When the tide goes out, you get to see who is swimming naked,” Warren Buffett has said. It’s uniquely true in healthcare. When the seas get rough, we will quickly divine which battleships are skippered by Bull Halsey and which vessels are stuck under the uncertain hands of Captain Queeg.

Michael Turpin is frequent speaker, writer and practicing benefits consultant across a 25+ year career that spanned assignments in the US and in Europe. He served as the northeast regional CEO for United Healthcare and Oxford Health from 2005-2008 and is currently Executive Vice President for Benefits for the New York based broker, USI insurance Services. He writes at Trexdad.com. This post originally appeared in the June 2014 edition of Leader’s Edge Magazine.

17 replies »

  1. Well said Michael. An excellent piece. I’ve been in the dance since the 70s.

    IMJ, Professor Reinhardt’s comment does contextualize the competitive repositioning drama unique to the healthcare industry’s soft competitive dynamics given other industry experience.

    We shall see whether ‘high value’ or ‘narrow network’ messaging arguments succeed in educating and/or assuaging both plan sponsors and their member or beneficiaries of the necessary reform trade-offs.

    Our whack-a-mole healthcarg borg has been pretty resilient.

    From a fellow recovering managed healthcare executive…

  2. Your statement that includes “Deciding to not pay for a chemotherapy drug”… means that you have accepted forced pooling.

    I don’t find any problem with people that wish to spend their money on insurance that provides them with what you might think to be excessive treatment.

    Life expectancy is not a metric that determines the effectiveness of a healthcare system.

  3. The “death panel” debate is a fraught with misconceptions.
    Whoever is the “payer” by definition wears the black hat
    by having to decide what gets paid for and what does not.
    When you have a culture that is grounded in the notion that access
    equals quality and that the length of one’s life is the measure of its quality,
    , you will by definition, end up with a conundrum of infinite demand and finite
    resources. Choosing not to pay for a 75 year old alcoholic to
    have a liver transplant so you can afford to pay for a child’s heart transplant seems like an easy trade-off. Deciding to not pay for a chemotherapy drug
    because a young mother of two lacks a bio marker that indicates low probability of efficacy is very hard.

    If a person goes broke trying to finance payment of a low probability treatments, it is a tragedy –as much for their love ones as for the person who wasted their resources trying to overcome the inevitable.

    In the UK, The National Institute of Clinical Effectiveness (NICE)
    makes those calls and has been periodically maligned for its
    seemingly insensitive algorithms that make hard calls on the cost/benefit
    of certain treatments. It all sounds great right up until it is us or someone
    we love. The UK spends less than the US per capita on health but does
    not suffer from lower life expectancy.

    Remember that not choosing to pay for a specific treatment
    is not the same as euthanizing the patient. Every country will always have
    a two tiered health system that affords those with money to fast pass
    to the head of the line or to pay for a treatment
    That may have a low probability of success.

    Life span has 40% to do with genetics but 60%
    to do with lifestyle and socioeconomic status — where you live, access to basic services and your per capita income. Meanwhile, we are already presiding over the greatest intergeneration wealth transfer as we fleece our kids and their kids with deficit spending. Much of the future deficits are driven by
    unsustainable Medicare costs. Hard questions and the need for some sober and yes, possibly controversial answers.

  4. Betty, there is a difference between saying we overemphasize care and stating that government should pick out an artificial time and place in one’s life that an individual should die.

    Is it worth it to bankrupt my family so I can live 3 months longer? Not for me it isn’t.

    We all take risks, sometimes we speed, sometimes we have risky hobbies, and sometimes we live in dangerous places. Money can save lives in more places than just the healthcare sector and at a much lower cost. Our big increase in life span didn’t come from doing open heart surgery and most of medical care. It came from creating sewage systems and clean water.

    That 20 year old in the ghetto isn’t going to benefit much from the millions and billions spent on preventative care. An added policeman, however, can save his and other lives.

    Think of the important things…Tradeoffs. What are you willing to trade off for that very small extra reduction in healthcare risk?

  5. What age do you think, Allan and Rick, hospitals and physicians should let patients go (die) so that you can pay for your new tires? If the tires and medical costs are that close for you, I would be concerned about your age as well. Because death is cheap (your words, Allan) why not let it happen to anyone seeking medical care over the age of 21 and then only the healthy people will survive. When care is needed, don’t provide it and save a lot of money for tires.

    Seems like we will soon be living in a country that does not care about its citizens. What kind of country will we be then? Who is to decide who dies and who lives?

  6. Rick, I believe we overemphasize healthcare to the detriment of our lives sometimes spending so much on preventing and attempting to cure disease that we aren’t left with enough money to pay for new tires. We then get killed in a road accident that new tires could have prevented.

    Sometimes when I look at a hospital I think of the giant pyramids of ancient Egypt.

  7. This is an illuminating post and I thank Mr. Turpin for it.

    It may trigger heart palpitations among hospital executives. But if I were their shrink, I think I’d be able to calm their nerves easily.

    After all, things could be much worse for the hospital industry. Most CEOs in the rest of the economy routinely face far more turbulence that can cause severe PTSD (Pre-Traumatic Stress Disorder)..

    For example, competitors all over the world might suddenly wipe out their market share for a major product with a better one, or put truly significant price pressure on their top line. CEOs in the device or pharmaceutical industry and many other industries relying on intellectual property are in constant legal warfare with competitors who claim patent infringements. If only a few patients die from one of their products, all hell can break loose. By contrast, in the hospital industry, the Institute of Medicine’s stunning TO ERR IS HUMAN caused barely a ruffle in the hospital industry. Society has been remarkably forgiving vis a vis the hospital industry — evidence of how much we love it.

    What we are witnessing in the hospital industry is merely a long-overdue shift from an era of “reimbursement” to one of “getting paid.” The cerebral shift this will require among hospital CEOs will take some time to take hold. But it should not be all that traumatic. A good CEO should be able to manage it.

    Finally, look at currently projected total expenditures on hospitals. CMS estimates that they will rise from $929 billion in 2013 to $1,581 billion in 2022, at an annual compound growth rate of 6.1%.

    An industry with good managers should be able to survive in America with that kind of collective revenue growth.

    In sum, to paraphrase Mark Twain, the reports of the hospital industry’s death have been greatly exaggerated.

  8. allan- I’m glad you said long lives need “a lot of care” not cure.

    Yet we actually have the hubris to believe that we can “cure” the degenerative diseases of aging. Some even believe that we can “cure” death itself? Therein lies a huge problem of ego and immaturity.

    A strong dose of humility is in order for US Organized Medicine as manifested most blatantly in tertiary treatment mega-hospitals

  9. Vik, prevention is wonderful, but limited and as you well know prevention doesn’t prevent death, it only delays. We get more frail as we age and more susceptible to other diseases. Death is cheap Long lives cost a lot of money and need a lot of care.

  10. If things get any worse, the Cleveland Clinic could ought to downgrade their building franchise from AN intercontinental to a motor hotel half-dozen.

  11. The EHR is costly, causing downgrades in bond ratings, in many centers. Machines replacing people.

  12. If things get any worse, the Cleveland Clinic may have to downgrade their hotel franchise from an Intercontinental to a Motel 6.

  13. The author provides an exhaustive treatment of the Hospital Industry filled with challenges, uncertainty and tough choices. But in 10- 20 years the Hospital Industry landscape will be even more difficult to recognize-because basically it will no longer be the bloated unnecessary industry we now know.

    There will be FAR fewer hospitals with government mandated reduction of redundancies and far more price and outcomes transparancies. Hospitals will continue to study the hospitality industry to become more patient centered and customer friendly.

    Excessive tertiary hospital based high technology will be rationed and the sin of excesssive profiteering off the dying will come to an end.

    Hospitals will continue to be forced into erasing the terrible stain of medical errors, hospital based infections, the paradox of poor health of healthcare workers and bearing the embarrassing reputation of morphing from healing institutions to being “dangerous” institutions.

    If prevention succeeds in the broadest sense to include individual (behavioral change) prevention and institutional (public health) prevention this will put hospitals under even more pressure

    The future of Medicine is not hospitals.