The recent articles in the New York Times about the Hospital Corporation of America (HCA) have once again raised important questions about the role of for-profit hospitals in the U.S. healthcare system. For-profits make up about 20% of all hospitals and many of them are part of large chains (such as HCA). Critics of for-profit hospitals have argued that these institutions sacrifice good patient care in their search for better financial returns. Supporters argue that there is little evidence that their behavior differs substantially from non-profit institutions or that their care is meaningfully worse.
To me, this is essentially an empirical question. Yet, I read the through the articles, I was struck by the dearth of data provided on the quality of care at these hospitals. Based on the comments that followed the stories, it was clear that many readers came away thinking that these hospitals had sacrificed quality in order to maximize profits. Here, I thought an ounce of evidence might be helpful.
There is no perfect way to measure the quality of a hospital. However, the science of quality measurement has made huge progress over the past decade. There is increasing consensus around a set of metrics, many of which are now publicly reported by the government and even are part of pay-for-performance schemes. While one can criticize every one of these metrics as imperfect, taken together, they paint a relatively good, broad picture of the quality of care in an institution. We focused on five metrics with widespread acceptance:
Julie Creswell and Reed Abelson offer a story in the New York Times about the HCA for-profit hospital system, noting “A giant hospital chain is blazing a profit trail.” The HCA story and similar ones about other hospital chains financed by private equity force us to consider how a such firms can achieve a return on equity that satisfies investors.
The answer is that they cannot, if we think about running the business on a long-term basis. What makes it work is extracting cash and the exit strategy, the heart and soul of private equity.
As Warren Buffett might say, let’s keep this simple. A for-profit hospital system has the following disadvantages vis-a-vis a non-profit hospital system: (1) Its finances are a mixture of equity and taxable debt, both of which are more expensive than the nontaxable debt of a non-profit; (2) it pays taxes–federal and state income tax, property tax, and sales tax–on which the non-profit is exempt; and (3) it is an unattractive vehicle for charitable donations, compared to the tax-advantages offered donors of non-profits.
These are hefty financial advantages for non-profits, which nonetheless are fortunate if they are able to earn an operating margin of 3%. Admittedly, that’s 3% of revenues, not a 3% return on capital.
An equity investor in a for-profit doesn’t care about margin, strictly speaking, but rather is focused on the rate of return of his or her investment. But let’s stick with the operating margin just for a moment, and let’s just accept that a 3% margin would not generate the kind of equity return demanded by the market place: You pick the hurdle rate: 15%, 20%, 25%, more? It doesn’t matter. A three percent margin just doesn’t get you there.
Last week’s New York Times article on cardiac care at some HCA-owned hospitals yielded a chorus of comments from readers who argued that for-profit hospital care is inherently low-quality care. As it happened, in working on a history of the investor-owned hospital sector, I had just been crunching data that might either support or refute that assertion. The results are surprising, if far from decisive.
Last September, the Joint Commission released the first of what it said would be annual lists recognizing “Top Performers on Key Quality Measures™” among the nation’s accredited hospitals. The all-star roster is based on “core measure performance data” that hospitals report to the Commission. The data cover adherence to “accountability measures ” established as best practice in the eyes of the Commission – making sure to prescribe beta-blockers for heart attack patients at discharge, for example, or to discontinue prophylactic antibiotics within 24 hours after surgery.
Unlike hospital quality measures that look at results – death rates and other outcomes – this one looks at processes. In theory, then, it ought to be more fair to hospitals that tend to serve sicker or more compromised patients, such as government-run hospitals in inner cities.
For more than a year, I have immersed myself in the history of for-profit hospital chains and their associated enterprises. My goal is to produce an account of the for-profit sector that will be a valuable resource to all parties involved in the serious health care policy-making that must surely take place in coming years.
Along the way, I have begun to understand the pressures that will soon make for-profit provider chains an even greater force than they already are – and will lead to an existential crisis in the non-profit hospital sector.
Hospitals wield immense influence in every city and county in the U.S. They are always among the largest employers in town. They touch the lives of all in the community as the sites of all births, most deaths and many health events in between.
Even the smallest hospital, in the smallest town, is worth tens of millions of dollars. Thus, for example, buyers in 2010 paid $28 million for a 124-bed facility in Marion, South Carolina (population 7,000), and $86 million for a 108-bed hospital in Ottumwa, Iowa (population 25,000). And at the upper end of the scale, another buyer acquired the 2,000-bed Detroit Medical Center for $1.5 billion.
Those buyers were for-profit hospital chains, and the sellers were non-profit operators. Some of the factors motivating such transactions have been around since the advent of the for-profit chain era in the 1960s – including inadequate access to capital for charities and local governments that needed to upgrade their hospitals, competitive pressure from deep-pocketed for-profits, and crises arising from poor management and governance. Although not-for-profit hospitals have long been coping with those issues and have often chosen to solve their problems by selling out to the for-profit chains, eighty percent of American hospitals are still non-profits, with about a third of those being government-owned. Those proportions are about to change dramatically.
I’ve noticed at The Health Care Blog quite a few people are obsessed with the role of profit in the health care system. Many apparently believe that for-profit entities have no legitimate role in an ideal world and that all organizations should be nonprofit.
My own view, interestingly enough, is the exact opposite. Were I a Health Care Czar, I would remove the nonprofit status from almost all health care organizations and force them to be for-profit under tax law. I would be willing to consider some exceptions here and there, and in special cases allow for-profits to set up nonprofit subsidiaries. But the vast majority of all patients in my ideal world would be dealing with for-profits — in getting health insurance and in getting medical care. And in return they would get lower-cost, higher-quality care.
Why do we have such radically divergent views on this subject? As so often happens in public policy, much confusion is caused when people are not familiar with basic economic principles. In this case, the antiprofit folks are confused about (1) the economics of capital, (2) the economics of competition and (3) the economics of motivation in complex social systems.
Suppose the government builds a hospital and plans to have the entity be self-sustaining (all operating costs are to be paid from expected revenues). Following conventional public sector accounting, the cost of the capital needed to build the hospital will be treated as zero. (Afterall, all we need is for the Treasury to write a check.) And even though the plan to cover costs with patient revenues is far from certain to pan out, the accountants will also ignore the cost of that risky decision.
This example is Exhibit A in my case for abolishing the nonprofit status of hospitals.