How Can Caritas Increase Its Profit (And How Will It Likely Increase Its Profit?)

In yesterday’s post, I reviewed the proposed transaction whereby a private equity firm would acquire Caritas Christi HealthCare System in Massachusetts.  Today, I’ll discuss approaches to improve profitability at any health care facility. Tomorrow, I’ll examine some potential exit strategies for Cerberus Capital, which proposes to acquire Caritas.

By the way, yesterday's Boston Globe had another article accepting the premise that the Caritas acquisition would lead to overall health system cost savings.  

All the benevolent talk of lower overall costs notwithstanding, successful delivery systems have to make money, whether they are for-profit or nonprofit.  Without a bottom line, hospitals can’t make investments in new technology, can’t offer the amenities patients demand, and often can’t even keep up with plant depreciation.  So – profit margin is absolutely necessary – for nonprofits OR for for-profts.

There are two ways for health care systems to improve their profit margin:

1.    Decrease costs
a.     Decrease labor cost through substituting less expensive labor (non-union for union employees; physician assistants for physicians)
b.    Eliminate or downsize programs with negative margin.  
c.     Eliminate or scale back money-losing facilities
d.    Fail to make new capital investments

2.    Increase revenue
a.     Increase number of patients seen
b.    Do more procedures on the patients already in the system
c.     Offer a mix of higher margin services
d.    Demand higher unit prices at the negotiating table
e.    Improve rates of collection
f.     Dissuade patients with “poorly paying” insurance from coming to your facility (and use this capacity for patients with “better paying:” insurance.

Decreasing the input costs of health care is the best way to drive increased margin.  Hospitals which figure out how to offer equally good (or better) health care with fewer resource inputs SHOULD gain a competitive advantage.   Increasing efficiency in any business is good – because it increases the overall value delivered to the customer.
However, in health care (and many other fields), it’s a lot more attractive to increase revenue than to decrease costs. Further, through multi-year labor contracts and commitments not to cut back on existing services and facilities --  Caritas has fixed many of its costs over the first years of this new arrangement.  So, to be profitable the system will need to increase revenue.  Many of de la Torre’s changes at Caritas have tilted toward increased revenue capture, including increasing cardiac surgery, use of robotic surgery, and investment in high cost imaging equipment (that once in place tends to be highly utilized.)  Even the new construction at Good Samaritan which will embed a CT scan in the emergency department will clearly raise overall collections for Caritas (thus increasing health care costs.)   Capital will largely be deployed where businesses like to deploy capital – where it will lead to surging revenue.

Increased revenue for the new Caritas system either means that overall health care costs climb further, or that other health care systems will see lower revenue.  Lower revenue is a terrible hardship for hospital systems, which have high fixed costs and therefore must make deep cuts if they suffer relatively small revenue declines.  Some have suggested that an invigorated Caritas will put more downward pressure on prices at the big Boston teaching hospitals. I believe that an invigorated Caritas will make strategic investments that will lead to higher revenue – some of this would be new revenue altogether, which raises overall costs.  Therefore, I’m skeptical that the new ownership is likely to lead to a diminution in the rate of health care inflation.

On the positive side, Caritas has engaged in a number of global payment (capitation-like) contracts - and these are payment methods where lower resource inputs lead to financial success.

In my next post, I’ll discuss Cerberus’ potential exit strategies, and implications for managing health care costs. 

Why Acquisition of Caritas Christi HealthCare System is Not Likely To Lower Overall Health Care Costs

(Part One of Three)
I thought my first post back from vacation would be about the passage of health care reform – but the news from Boston that Caritas Christi, a six-hospital system which has been owned by the Catholic Archdiocese of Boston announced that it intended to sell itself to Cerberus Capital Management.  Many commentators have weighed in on the possibility that this would increase provider competition in the greater Boston area, and that the investment from Cerberus would lower overall health care costs.  The initial Boston Globe article  even said that the acquisition would “turn what had been debt and pension payments into cash flow.” The Globe editorialized in favor of the move, although with a small amount of caution.

In today’s post, I’ll examine the transaction, and hypotheses for how this would lower overall health care costs. The second post will concentrate on how hospital systems make money, and the final post will examine different ways Cerberus could benefit from its investment in Caritas Christi over time.

First, the transaction itself:
Cerberus will put up $830 million, which will allow the system to retire its debt, fund its pension plan, and make some investments and repairs to make Caritas hospitals more attractive to patients.   In exchange, Cerberus will gain ownership of the capital assets of Caritas Christi, which it says it wants to make the nidus for acquiring additional hospitals across the country.    Cerberus has pledged to honor existing labor contracts, continue existing programs, and maintain existing facilities for at least three years, during which time it will not receive any return on its investment (although presumably will be able to pay itself management fees).  The facilities will continue to honor Catholic precepts, and not offer full reproductive services.  As for-profits, the facilities will pay local property taxes (worth $7 million per year to Boston alone according to Mayor Tom Menino.) After the three year period, Cerberus will no longer be obligated to maintain programs, and would be free to ‘cash out’ of its investment.

Ralph de la Torre is quoted as saying “We are committed to being a regional, community-based system that lowers costs.’’  

How could this sale to Cerberus lower costs?

1. Substitution of capital for labor
Cerberus’ new dollars could mean that the system could make investments that would allow it to lower the resource cost of medical care in the future.  However, Caritas’ labor costs are fixed through the end of a four year set of union contracts, so the labor savings will at best be minimal.  Therefore, I conclude that it’s not likely that this new capital influx will lead to lower labor costs at Caritas.

2. Use of capital to decrease other input costs
de la Torre specifically notes that capital to deploy electronic medical records can decrease duplication of services.  That’s true – and much remarked upon – but the marginal costs of duplicated services are quite low, and there is an emerging consensus that EMRs make health care better, but don’t really decrease costs a lot.
3.    Better management
Private equity firms often pick up underperforming companies and impose new, highly disciplined management.   In this case, Cerberus says it will maintain the current leadership team, which has been credited with turning Caritas around.  If there is no change, this is not one of the ways the Cerberus investment will lower overall health care costs.
4.    Make Caritas’ facilities more attractive to patients who would otherwise go to more expensive facilities This is the “we’ll take the business from Partners” argument. The Attorney General’s recent report shows huge cost differentials from high cost to low cost providers, without substantial quality differences.  That report confirms that Caritas is a relative low-cost provider.  If patients choose St Elizabeth’s over Mass General in light of these new investments, costs are likely to be lower.  However, if Caritas Norwood Hospital takes business from nearby Milton Hospital (instead of more expensive South Shore or Brigham and Womens), costs for the overall system will instead rise.

My conclusion is that it’s wildly optimistic to suggest that this capital influx will lead to overall cost savings in Massachusetts.  Undercapitalized hospitals generally have lower costs, while well-capitalized hospitals generally have higher costs.  However, it will be very difficult to turn the application down, as an underfunded Caritas clearly cannot compete against the other health care delivery systems, and the system is an important safety net provider and an important source of jobs in many communities.

Next Post: Improving hospital profitability

April Harvard Business Review

I'm still in Laos - with a plane-worth of reading to do to catch up.  Regular posts will begin next week, although I'll try to send something from the 8000 mile ride back.

Of note, the April Harvard Business Review includes an infographic I wrote (with much editorial assistance from Gardiner Morse of HBR) on the causes of health care cost increases, and a few potential answers.  Here is a URL for a "teaser."  Subscribers can view the entire article on line, and Harvard-affiliated readers can access this through the Harvard Library - but the April issue won't be available until next month.  Many of the topics here will be familiar to readers of this blog.

For nonsubscribers, the issue has an interview with Atul Gawande (recent author of The Checklist Manifesto, noted in the column on the right), and articles on improving the delivery of care by Richard Boehmer of HBS and Tom Lee of Partners and Harvard Medical School.   I'm looking forward to seeing my copy!

Selected URLs

I'm traveling - so not doing full postings.

A few articles of note

The Boston Globe reports that Harvard Pilgrim has identified which providers are paid the most for different services.  This is not risk adjusted - but the differences are far larger than you'd expect to be eliminated by risk adjustment.

The New York Times reports that more physicians are dropping out of Medicaid because of fee cuts.  The article also points out how difficult it is to care for Medicaid patients when many cash-strapped states eliminate vital benefits?  How do you treat a Medicaid beneficiary with an infected tooth when dental is no longer covered?  Not well, obviously.

The LA Times reports that the number of uninsured in California continues to rise rapidly - now approaching a quarter.  The issue of how to pay for health care for the uninsured grows larger by the day.

Childhood Obesity Month

(Diagram of childhood obesity prevalence by state from March Health Affairs. Red is significantly higher than US, Yellow is higher but non statistically significant, Blue is lower, and Green is statistically signficantly lower)

I'm long overdue for a posting - and I've been thinking a lot about childhood obesity lately.

I'm not the only one - Michelle Obama is evangelizing to take action to increase activity and decrease kids' caloric intake.  There are efforts to impose sweetened beverage taxes in New York and elsewhere.  And this month's Health Affairs has a whopping 80 pages in the March issue on this topic.  (Health Affairs just changed to a larger format.  The new version looks absolutely beautiful, and allows printing useful color graphics like the one at the top of this posting.

I'd like to mention two efforts, both from the Boston area, to address childhood obesity.  Health Affairs published a study of a multidisciplinary team approach to childhood obesity at Boston Medical Center.   The team included a pediatrician, a nutritionist, and a case manager - and was based at community health centers. It incorporated health care IT, and children and their parent(s) attended sessions every 1-2 months for six sessions and early results suggested that of the 174 children who had at least two visits, 80% made at least one improvement in lifestyle (less screen time, better nutrition, more exercise) and 50% had a lower BMI.  This is preliminary  - and it's exciting, because so little about treating childhood obesity seems to work.

The other effort is not based on the medical model, but is rather based on a public health model.  Shape Up Somerville,

Here are two paragraphs from the Boston Globe describing the program:

Pedestrians in this city of 77,500 stride onto bright, recently striped crosswalks. Bicyclists, who until this year navigated traffic aided by a single bike lane, enjoy 2 additional miles of designated lanes, and almost 4 more are planned. In school cafeterias, fresh produce has replaced canned fruits and vegetables, and the high school retired its fryolator. The Neighborhood Restaurant now serves wheat oatmeal waffles with bananas in addition to bacon and eggs. Budding salsa dancers step-two-three in a new Recreation Department class that costs just $10 for two months of twice-a-week lessons.

These scenes might seem to be mere background noise to the bustle of a diverse city of artists and immigrants, laborers and lawyers. Yet changing the background noise has placed Somerville in the vanguard of communities putting environmental and policy changes - rather than exhortations to modify individual behavior - at the center of their fight against obesity. 

Essentially, the idea is to make it easier for people to live healthier lifestyles - not merely to pester them to improve their individual behavior.   Shape Up Somerville has one excellent statistic - the Tufts University researchers who helped set up the program say that kids have gained 15% less weight (one pound) compared to a control group.  That's a big deal with huge potential implications.

The real social question is which of these approaches is sustainable.   We will need the medical model for a select few children - but we need to set up more public health approaches.   And yes, let's tax sweetened beverages too!

I'll be taking a break from Managing Health Care Costs for the next two weeks - I'm now in Los Angeles on my way to Hanoi to cycle to Luang Prabang Laos.  If you're interested in reading about this adventure, I'll post at (assuming I find internet cafes!).

The cost of doing nothing, part two

The Boston Globe had a two-part series on the cost of health insurance for local governments in Massachusetts that began on Sunday.  

Health care costs went from 8% of local city and town budgets in 1999 to 14% over 2009.  This creates a real crisis of crowd-out – that 6% of the budget now used to pay for health care is no longer available for the other things cities and towns do – largely schools, police, fire departments, and roads. Cities and towns provide a great illustration of the threat posed by massive health care cost increases.

The Globe articles focus on the role that unions and local town politics  have played in the burgeoning health care costs.  Some municipalities don’t force eligible retirees over 65 to use Medicare as primary insurance ($5m bill for Boston alone), many offer “Cadillac plans” that have very low copayments, and some even still offer indemnity health insurance plans.  Few have joined the state’s purchasing agency, the Group Insurance Commissioner (GIC). State law makes it easy for a single union to stymie a town’s transition to the GIC, and even requires a municipal vote to require transition to Medicare.   Many towns offer lifetime health coverage to those who have held office or been on commissions for as little as 10 years. Government retirees and employees vote, and therefore these requirements are difficult to meet even if the alternative is to close the library,  lay off teachers,  and stop repairing the potholes.

The Globe has editorialized about the need to reform state laws that make it difficult for cities and towns to address these cost  increases through cost-shifting to current and former employees.

This series is another good example of how our current system with its rapidly increasing costs is unsustainable.   Suggested changes in state law are prudent – but a real solution to this crisis will require meaningful health care reform that will lead to lower rates of health care cost increase.