The Perfect Storm

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 strange bedfellows. Systems like Sutter Health and LIJ have sought to become “payers,” and insurers slowly dip their toes in the water of healthcare delivery by acquiring primary care practices, such as Humana’s acquisition of Concentra.

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.