The Rx for M&A

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March 2017
By Emily Donovan
Chicago Lawyer correspondent

In the last few years, there has been such a frenzy of hospitals thinking they’ve got to merge and get bigger that Keith R. Anderson compared it to a school dance for teenagers.

“Health systems don’t want to be the last person on the dance floor without a partner,” said Anderson, a partner at Drinker Biddle & Reath who has been practicing in health-related strategic affiliations for about 30 years.

But rushing into a relationship — or, rather, a strategic affiliation — just because all your peers are doing it isn’t always a smart move.

“People have been thinking about affiliation transactions many times without taking that first step and thinking about what they really need and what their objectives really are and what the possible routes are,” Anderson said.

There’s been a boom in hospital mergers and acquisitions since the Patient Protection and Affordable Care Act was enacted in 2010, according to analysis by Kaufman, Hall & Associates. He expects the upward climb to continue.

In 2016, 102 transaction deals were announced across the nation. In 2015, 112 deals were consummated. Both are a big jump from the 66 deals announced in 2010.

In the Chicago area, recent health system partnerships include Ingalls Health System becoming part of the University of Chicago Medicine, Elmhurst Memorial Healthcare and Edward Hospital and Health Services merging into one and Northwestern Memorial Healthcare and Centegra Health System announcing they were considering an affiliation.

Meanwhile, Little Company of Mary Hospital is considering its options after it put out a request for partnership proposals in late 2016 and Advocate Health Care and NorthShore University HealthSystem’s merger has been put on hold as the two health-care systems fight an antitrust lawsuit.

Despite the increase in hospitals affiliating, a 2016 study conducted by ORC International that was commissioned by McKesson Health Solutions found that 60 to 78 percent of health providers surveyed are not meeting their goals to reduce administrative care costs, lower health-care costs or coordinate care.

This means more hospitals and health systems are partnering up, but aren’t necessarily making their health care cheaper.

Like in all relationships, Anderson and other merger experts recommend hospitals know themselves and make sure their potential partners want the same things. Hospitals should date or make sure they’re compatible before they set out on that dance floor together.

Why all the partnerships?

Until recently, health insurers paid hospitals a fee for the service rendered.

Let’s say, for example, that a patient needs a knee replacement. The patient has a surgery then is in recovery for some time after that. If the surgery doesn’t work quite right, they might need a second surgery and more recovery.

Under a fee-for-service based payment structure, an insurer would pay the hospital for the surgery and would pay the hospital again if the patient needs more surgery.

“It’s pretty easy to operate under that metric,” said Kit Kamholz, managing director of Kaufman, Hall and Associates, a health-care consulting company based in Skokie. “If you perform a service, you get paid for it.”

But, after the Affordable Care Act was passed, Medicare started to roll out a values-based payment model. Around the same time, commercial insurers started using more value-based payment plans too.

Under that model, the insurer might pay the hospital a bundled amount for surgery and all the necessary care for the next 90 days. If the patient needs another surgery, there’s no more reimbursement coming.

For a hospital to break even in a value-based payment model, the knee operation has to be cost efficient and it has to work or else the hospital might be going in the red to put the patient under the scalpel again.

According to that OCR International study, value-based reimbursement will “eclipse” fee-for service payment models by 2020.

As of March 2016, the payers ORC International surveyed said they were already 58 percent of the way toward full value-based reimbursement — which is a 10 percent increase from 2014. The hospitals surveyed said 50 percent of their payments are from value-based reimbursement — a 4 percent increase from 2014.

That, Kamholz said, is what’s motivating a lot of hospitals to re-evaluate if they can be cost-efficient on their own.

While some organizations affiliating these days may still be under the kind of financial distress that have motivated selling out to a larger system in the past, more and more organizations that are financially strong are realizing they need to become part of a bigger system to adapt to the market’s changing needs, he said.

A fast start

Attorney Chris J. Mollet was less than 45 days into his new job at Edward Hospital and Health Services when he learned Edward Hospital and Health Services was trying to become something else.

Mollet, now executive vice president and general counsel of the joint Edward-Elmhurst Health, has been representing hospitals since 1979. He joined Naperville-based Edward Hospital and Health Services in August 2012 as vice president of legal services and general counsel when he found out his employer was in merger talks with Elmhurst Memorial Healthcare.

It was “a fast start,” Mollet said, but he knew transactions in the Chicago area had been on the upswing, so it wasn’t a surprise to him to find he would be working with outside counsel to merge.

The organizations’ leaders knew each other and they both used some of the same consultants. Both of their facilities were fairly new. Plus, merging would allow them to build up their relationship with DuPage Medical Group, the largest physician group in the area.

Mollet said a hospital interested in a merger or acquisition should do an honest SWOT self-evaluation: What are its Strengths, Weaknesses, Opportunities and Threats?

“Looking at what that might mean for a potential affiliation, the first question should be ‘Do you even need to do it?’” he said. “Or do you have the resources internally that would allow you to enhance your strengths, address your weakness and take advantage of the opportunities?”

A hospital should do a similar analyses of potential partners, Mollet and Anderson said. Can that partner actually protect the organization from its threats?

Anderson, who counsels health-care clients on transactions, said analysis is the first step to a successful affiliation. When he first gets involved with a client, he said he wants them to take a hard look at where they’re at and then think about where they need to be in five years. Then, he said, they should set out to figure out what their options are.

One possible type of affiliation would be a change of control, which would oust the governing board and give control to a bigger health system.

There are also ways to keep local control but still work with another, larger system. For example, Anderson said, there are a number of health systems willing to contract out their information-technology resources and staff to a standalone community hospital.

That small community hospital may need a large IT department to implement an electronic health record system, but it wouldn’t need 10 to 12 full-time IT people once the electronic record is up and running.

These kind of affiliations offer more than access to capital for new gadgets or constructing another building. Being part of a larger network can help a small hospital attract and retain talent.

“You really need access to people who have the experience and the intellectual horsepower to be operating in this growing, sophisticated health-care system,” he said.

Sometimes, a hospital may call in a third-party analyst or consultant to help assess where the organization is really at and what other health systems across the nation may be interested in affiliating.

That kind of controlled, competitive search usually yields the best result, Anderson said, but he doesn’t like to generalize. Sometimes, a hospital’s specific market, doctors, insurance and other factors may align and that by partnering with its hospital friend down the street works out well.

“You do one deal, you do one deal,” he said. “There’s not a cookie cutter out there.”

Trust and antitrust

What was attractive to both Edward and Elmhurst, Mollet said, was that their primary service areas across DuPage County butted up next to each other but didn’t overlap.

That likely helped the deal pass antitrust review, Mollet said.

That test is what’s stalled another intended merger in the Chicago area, this one between Advocate Health Care and NorthShore University HealthSystem.

The Federal Trade Commission argued a merger between the two systems in Cook and Lake Counties, which would create the 11th-largest health system in the country, would harm competition and lead to higher prices. The FTC says the merged network would control 60 percent of the north suburban hospital market, but the health systems say the FTC wrongfully excluded some competitors in that calculation.

In December 2015, U.S. District Court Judge Jorge Alonso sided with the health systems, but the 7th U.S. Circuit Court of Appeals ruled that his decision was “erroneously flawed” in October and sent the case back down to the lower court to reconsider issuing a temporary injunction stopping the merger.

In a statement, Advocate and NorthShore said they believe merging is the right thing for their potential patients and therefore will move forward with the case.

“We are confident that Judge Jorge Alonso made the right decision in our favor this past summer, reaffirming the competitive realities of the Chicago market,” the statement says. “We look forward to a positive resolution — paving the way for an innovative care delivery model to further advance quality and lower costs.”

Edward and Elmhurst weren’t competitors, Mollet said, just neighbors. Their affiliation could be seen as expanding their collective geography rather than establishing any kind of monopoly over an overlapping area.

The hospital systems signed a letter of intent in early January 2013 and closed on the merger on June 30 that year. In that time, general counsels and outside corporate counsel drafted a letter of intent, defined a written agreement and worked through regulatory filings.

“It’s full employment for lawyers, that’s for sure,” Mollet said.

Mollet said the literature suggests that in the majority of mergers prices are not necessarily reduced for customers.

Only 22 percent of hospitals surveyed by OCR International last year said they were meeting their goal to reduce administrative care costs. Only 26 percent were meeting goals to lower health-care costs and only 30 percent were meeting care coordination goals.

But Mollet said Edward-Elmhurst developed a 100-day plan and a three-year pro forma of what costs the organization thought could be save.

“Long story short, we have overachieved in every year in the three-year pro forma in terms of what we thought we could accomplish: financial results, clinical information results, labor integrations,” he said.

The future

Regardless of what happens on the governmental front with the Affordable Care Act under the Trump administration and a Republican Congress, Kamholz expects commercial insurers to keep moving toward value-based reimbursement.

“It’s good business and we think that that’s going to continue,” he said.

Therefore, he said, he expects the increase in hospital mergers and acquisitions to keep climbing too.

“I don’t think that all the good work that’s done around trying to reduce the cost in health care is going to get reduced,” Kamholz said.

Mollet agreed that, regardless of what happens at the federal government or state regulatory levels, commercial insurers are continuing to move toward value-based reimbursement.

Mollet said the future of health law will be changed as millennials become the largest segment of the population and health-care adapts to their care delivery preferences.

Legal issues could arise as remote-diagnosis “telemedicine” grows in popularity. If a dermatologist in Missouri uses a computer screen to diagnose and prescribe medication for the rash of a patient from Illinois, but the dermatologist isn’t licensed in Illinois, there could be an issue of practicing without a license. Plus, some telemedicine isn’t reimbursable by insurance companies yet.

The law is always “kind of dragging its feet,” Mollet said.

But how dynamic the health-care industry is — and the wide breadth of legal issues it touches on — has always been what Mollet finds most satisfying in his career.