Two men are sitting in a bar, arguing over the best way to maximize the value of a house. One man, who works in corporate medicine, proposes to redo the kitchen and add a bathroom. The other, a manager at a private equity firm, says to burn it down and try to collect the insurance money. This conversation illustrates how the timeframe of an investment can influence people’s thinking. Compared to the private equity manager, the longer view of return on investment of someone from the corporate world inevitably influences their investment strategy for the “house”, or for this blog post, a “hospital” (i.e. research and development, employee training, improved safety for staff and patients).
In light of this difference, increased uncertainty exists concerning a new idea: private equity (PE) firms purchasing and operating hospitals. PE firms are in business to make a return on their investments based on a better understanding of finance. Fund managers and their investors rarely have expertise in health care; they view it as just another market opportunity. Making a profit on day-to-day hospital operations is also not in their “wheelhouse.” PE firms recruit capital from individual investors qualified because of their high net worth. Then they use this money to buy hospitals, transform them, and rapidly sell them—hopefully, for a profit. This new mode of ownership interrupts the status quo: investor-owned hospital corporations that obtain capital by selling shares to the public (which trades on a stock exchange), and by taking on debt through financial transactions arranged by investment bankers on their behalf. Multiple federal laws and agencies, including the U.S. Securities and Exchange Commission, regulate corporations. Both raise capital for investing purposes, but only PE firms have their own funds tied up in hospital investments, which turns them into corporations on steroids.
Concerns that clinical care deteriorates at US hospitals soon after they are purchased by private equity firms were recently brought to light by New York times and other national news outlets citing recent research published in JAMA. The study, which analyzed patient outcomes after a private equity fund bought a hospital, showed a wide array of preventable adverse events started happening –surgical infections and bed sores rose by 25 percent, patient injury due to falls by 27 percent and central line infections by 38 percent. When taken together with other evidence, the authors conclude that the control of a hospital by a private equity fund is what causes these bad outcomes.
The most likely reason for this relationship is the business model of PE firms. Having your own money at risk creates an incentive to focus on short term returns; buy low and sell high. Corporate hospitals in the US are one of the world’s largest buyers of hospital equipment. They enjoy deep discounts and strong operational expertise that excel at controlling costs and operating at a profit. PE firms without these advantages systemically undervalue long-term gains over short-term ones, making them more likely to resort to cutting cost in areas at risk for compromising patient care. This includes cuts in nurse staffing ratios or reducing patient visit times with their physicians, more aggressive efforts to influence physician upcoding and greater reliance on nonphysician practitioners. In the long run, these changes cause the intrinsic motivation to work in healthcare to be replaced by extrinsic control. PE firms do not pay the hidden costs of these interventions because they benefit from a legal double standard. They have effective control over the hospitals their funds buy, but are rarely held responsible for the hospital’s actions. This mismatch helps to explain why private equity firms often make such risky or shortsighted moves that can imperil their own business.
Some people take a contrary viewpoint and value the positive aspects of PE firms. The CEO of the American Investment Council, the largest lobbying group for PE firms, responded to the New York Times report by pointing out that PE firms provide underfunded hospitals with the capital that they wouldn’t have access to otherwise. Hospitals that receive this financial support end up with improved patient care, expanded access and more innovation. All of this strengthens health care. Clearly, raising money the old way through investment banking had its problems— twenty years ago it gave us the subprime lending crisis, and forty years ago, the savings and loans fiasco. Investment banks, confined by new regulations like the 2010 Dodd Frank Act, are curtailed from holding risky assets such as low-rated debts, limiting their ability to finance start-up or failing hospitals. Moreover, hospital corporations have been ineffective at addressing the rampant problem of hospital waste. Control by PE firms is seen as a sorely needed innovation with a chance of succeeding where others have failed by virtue of having more ‘skin in the game’: the energy, fresh perspective and greater discipline to drive cost effectiveness. Many see PE as an idea worth considering, to create long-overdue positive change in health care.
Datasets like that used in the JAMA paper provide only a 30,000 ft view of the problem, leaving the debate about PE ownership in hospitals unresolved. To get a fresh perspective, we need to zoom in—get into the weeds and induce conclusions from concrete examples of how specific hospitals have fared under the control of PE owners. PE firms aren’t typically required to follow the same public reporting rules of corporations so their financials are usually proprietary information. However, once PE firms buy hospitals that situation changes; they become required to submit a Medicare cost report with detailed, publicly reported financial information. This gives us a look into books of the private equity firm named The Convergence Group (TCG, headquartered in Puerto Rico and Colorado Springs, CO). They started a Healthcare Fund that raised at least $30 million from 80 investors and invested in Three Crosses Hospital (Las Cruces, NM) and Rock Regional Medical Center (Derby, KS). Both facilities appear to now be in financial distress. Based on Medicare costs reports, in 2021 Rock Regional lost $11 million and in 2022 they lost $20 million (negative 24% margin). Three Crosses lost $21 million in 2021 and $44 million (negative 18% margin) in 2022.
When a hospital loses that kind of money, it is fair to ask where it was spent. TCG has been the target of a publicly reported SEC investigation, which provides an even deeper level of transparency into their financial operations. According to SEC allegations (which have now been dropped), during the same timeframe that Three Crosses lost $65 million on hospital operations (2021-22), it was required to pay $3.2 million in fees to TCG ($250,000 fees to manage hospital construction, $500,000 fee to manage operations, $1.6 million sponsorship fee, $750,000 financing fee, $100,000 accounting fee). Similar fees were paid to TCG by Rock Regional. Federal tax policy treats these fees as long-term capital gains with a more favorable tax rate than ordinary income. Following the model of a leveraged buyout that is typical for PE firms, the money to pay these fees was obtained by Three Crosses taking on debt. This debt and its unfavorable interest payments terms were the obligation of Three Crosses, not TCG.
Furthermore, both hospitals also spent >$100,000 during these two years on registered lobbyist Landon Fulmer to argue that these hospitals are entitled to COVID relief funds. Executives from both hospitals blamed their state of financial distress on COVID and the failure to receive compensatory funds from the U.S. Department of Health and Human Services. However, this argument fails because Medicare reports show that the COVID pandemic actually improved the profitability of most US hospitals. In fact, local corporate competitors in the same neighborhood of Three Crosses were massively profitable during this timeframe (Memorial Hospital profits of $30 million (+1.9 margin); Mt View profits of $70 million (+ 5.7% margin)). The same was true for Rock Regional, with Ascension Via Christi St. Teresa located within 10 miles showing a $9.4 million profit (positive 4.3% margin).
When a hospital is under financial strain, it is also important to find out where money is not being spent. The CEO of Rock Regional, Barry Beus, stated in a local newspaper report in 2022 that the only thing that’s saved the facility from financial ruin is the cooperation of doctors, contractors and vendors who haven’t pushed for payments. On Oct 16, 2023, an anonymous report on Glassdoor.com stated that at Three Crosses the “hospital is going broke and not paying its vendors.” There are two things that are true about a hospital not paying its physicians and vendors. First, they do not have enough cash flow to make ends meet, an unambiguous sign of severe financial distress. Second, their staff are demoralized. Just because they are not taking legal action for past due payments, does not mean key stakeholders will continue to stay loyal. No one wants to be a sucker, particularly if the owner TCG was getting paid millions. At some point, restocking the shelves with critical supplies stops and staff stop showing up to work.
A patient admitted to a hospital in financial distress like Three Crosses is an unwitting participant in Russian Roulette. They never know if they will require a resource that is not available and don’t realize that the hospital is in a catch-22. The only way to resolve the financial crisis is to admit critically ill patients that reimburse well from insurance companies, like those with heart attacks. On the other hand, an occluded coronary artery might not be properly opened up if the correct sized stent is not available on the shelf, which puts their heart muscle in jeopardy. This is just one example of the types of preventable adverse events mentioned in the JAMA report that happen without the appropriate staff and/or supplies.
A similar thing happened as Hahnemann hospital was being shut down by a private equity firm in 2019. This situation received national attention when then presidential candidate Bernie Sanders joined the picket line and said “what people have got to do, not only in Philadelphia – hospitals are being shut down all over this country – is to stand up and say health care needs have got to be the first priorities, not huge profits”. Staff on the picket line that were interviewed at the time state that they tried to order basic supplies but vendors were turning them down, saying that the hospital hadn’t paid its bills. Staff and physicians both clearly noted that patient care suffered at this time.
The story of Three Crosses and Rock Regional hospitals cuts against the view of those that see modern PE firms as scrappy visionaries with the pluck and acumen to turn around ailing hospitals. Those that run PE firms generally have experience in finance, not medicine or hospital operations. The expertise that they bring to a hospital is financial expertise. Prior to investing in hospitals, TCG had investment expertise across a wide range of industries including retail, finance, banking, hospitality, construction, and blockchain. When firms like TCG think that they do have operational experience in a technical field like healthcare, it often blows up in their face and leads to massive financial losses like at their three hospitals.
PE was a reasonable model for hospital ownership when it involved physician investors using their own funds. Physicians have insider knowledge of medicine and hospital culture that lends great credibility to their management. Their expertise gives them unrestricted access to information, which allows the physician-owner to look under the hood to determine whether changing a business strategy is truly warranted. Modern PE firms don’t involve physicians and want to actively manage hospitals based on a much different underlying motivation. The managers in control fancy themselves as beleaguered captains liberating a bloated healthcare system from ineffective executives of corporate medicine, valiantly trying to keep our system from being sunk in a perfect storm. In reality, many are like barbarians inside the gate who loot and leave their hospital to sink, along with patients and staff, as they sail away safely with their profits.
The management style used by firms like TCG risks changing norms of behavior within its hospital from altruistic to selfish. Overemphasis on financial incentives beyond what is already the standard today in corporate medicine can introduce conflicts of interest that threaten a trusting patient–physician relationship. Their emphasis on driving profitability as soon as possible has hidden costs that we learned from the story of the goose and the golden egg. CEOs under this business model are less likely to take bold positions or invest in projects that fail to yield immediate returns. Instead, they force out golden eggs as fast as they can, which ultimately kills the goose (hopefully after the hospital is sold).
The widespread national interest in the JAMA article coincides with a growing public and congressional unease and scrutiny of this means of hospital ownership. However, there is a huge hill to climb before we should expect anything to change. Our country’s most important financial regulator is the Treasury secretary. Of the last eight people who have held that office in the past, four became heads of private equity firms after leaving their post: Steven Mnuchin (Trump), Timothy Geithner (Obama), John Snow (Bush), Lawrence Summers (Clinton). Each was sympathetic enough to the interests of this PE sector while in office as a regulator that he had no difficulty finding a very senior, well-paid position in it once he left the job. Those in political positions that don’t join PE firms are under tremendous lobbying pressure. From 1998 through 2023 the finance industry spent over $11 billion on lobbying; the only sector to spend more was health care ($12 billion).
With that kind of tailwind behind PE firms, it is reasonable to suspect that the system might be gamed, which is why it seems to be easier than it should be to profit on a hospital that eventually fails. If true, it can divert the motivations from having ‘skin in the game’ towards an unproductive form of entrepreneurism. For example, a PE firm that extracts a variety of fees (management, accounting, sponsorship) from a hospital that is in financial distress is not also going to make investments with a long term timeframe for a return on that investment. Such actions are mutually exclusive. Doing something that financially hurts the hospital makes it less likely for the managers of the PE firm to want to engage in activities that help the hospital. The easy financial rewards of hurting make it less attractive to take the risky and harder way of helping.
Corporate medicine has been disparaged like a teenager complains about their parents. To many, the whole idea means hospitals being owned by some faceless hierarchy in another distant city. It implies impersonal, mechanistic care. That sounds bad, but to paraphrase Winston Churchill, it is the worst way to run a hospital except for all the other ways that have been tried from time to time. The alternative–ownership by PE firms–doesn’t seem to realize why financial decision makers shouldn’t interfere in hospital operations. In this highly specialized field, it’s safer for both patients and long term organizational success to leave major decisions to healthcare professionals with operational experience.
robpostonblog 