Racing toward market mania

Modern Healthcare

Mary Chris Jaklevic

January 5, 2004

The new year brings a host of changes for the healthcare industry, many of them sparked by the new Medicare reform law that sets the course for hospital-physician relations, private-sector involvement in Medicare, consumer driven health plans and provider quality incentives.

But while 2003 was a year of federal policymaking action, expect a flurry of marketplace activity in 2004. And look for state governments, which were diverted by unprecedented deficits in the past year, to spice things up with new policy measures that could foretell changes at the federal level after the November elections.

Rising costs will remain a top issue, contributing to employer discontent and swelling numbers of uninsured, and making it a likely target in the presidential campaign. But significant congressional action to increase coverage is unlikely given the federal budget deficit and a lack of political consensus over how to fix the problem.

Likewise, with the CMS' activist chief having departed at year-end for the private sector, some believe the agency is unlikely to initiate bold policy initiatives until after the election. If a replacement for Tom Scully is named, some observers say it is doubtful that person will be willing to wade into controversial waters during an election year.

Expect continued health plan consolidation, cost-shifting to consumers, and links between quality and pay. Having divested their organizations' noncore assets, many hospital executives will fixate on capital planning and operational issues that affect profitability, such as collections and supply chain management.

As the year opens, hospital executives can be thankful for the Medicare Prescription Drug, Improvement and Modernization Act of 2003 that generously increases inpatient hospital rates and imposes an 18-month moratorium on competing physician-owned specialty hospitals. But the worry column for providers contains nagging high costs for malpractice insurance and labor; expectations that hospital bad debt will rise because of larger numbers of uninsured and under- insured patients and employee cost-sharing; and new concerns about long-term capital access and the potential for an approaching physician shortage.

Targeting healthcare costs

Employers' healthcare costs are expected to rise 12% this year, which while still a double-digit hit would mark the first slowdown in annual rate increases in five years, according to a survey of 200 large companies, released in December by benefits consultant Towers Perrin. Premium rates rose 16% this year, according to the firm.

Meanwhile, the population of uncovered Americans is likely to expand. The Census Bureau last fall reported that the number of people without health insurance grew by 2.4 million in 2002--the largest increase in a decade--to 43.6 million. Figures for 2003 won't be released until fall, but Paul Ginsburg of the Center for Studying Health System Change expects an increase similar to 2002 based on increasing premium costs. He also predicts a smaller but still substantial increase in 2004, tempered by employer cost-sharing, a slight slowdown in premium increases and a stronger economy.

In this climate, expect investors to favor companies that claim to be able to control costs, such as those in utilization review and disease management-specialties that fell out of favor in the late 1990s as managed care waned. ``We think those companies that can help contain costs are going to be very valuable again,'' says Richard Tadler, managing director in charge of the healthcare practice at TA Associates, a Boston-based venture capital firm.

The uninsured: Looking for a mandate

Not since 1992, when Bill Clinton swept into office on a healthcare reform platform, has lack of health coverage been so ripe a political issue. ``A lot of people are worried about becoming uninsured in the future or just not being able to afford health insurance. These are the conditions we saw in the early 1990s,'' Ginsburg says.

President Bush is expected to announce a plan to increase the number of covered Americans through tax credits and other means favored by conservatives to compete against the raft of healthcare proposals put forth by Democratic challengers. Whoever wins the White House in the election may claim a mandate for action on the issue.

At the same time, look for more than rhetoric at the state level. Reducing the number of citizens without insurance is the top healthcare issues for state lawmakers this year, according to a survey by the National Conference of State Legislators. With state budget outlooks somewhat brighter, some 43 states indicated that they will implement policies to address the uninsured, according to the organization. Meanwhile, 42 states say controlling Medicaid drug costs will be a policy priority.

Insurers: More changes, more profits

Insurers face a potentially tough year given a likely moderation of premium increases. Still, profits are expected to remain buoyed in part because of unprecedented consolidation that could reduce premium price competi-tion. Mergers and for-profit con- versions of Blues plans will continue to concern consumer groups and providers. Anthem's pending acquisition of WellPoint Health Networks would make it the largest health plan in the country, with 26 million Blues members in 13 states and $36 billion in revenue.

This year could mark a watershed for so-called ``consumer-driven health plans'' such as tiered provider networks and health savings accounts (HSAs) that encourage consumers to be more responsible for their healthcare spending decisions. A push came in 2003 from the new Medicare law, which gave employers the ability to offer tax-favored HSAs that can be can be funded by employee contributions or pre-tax payroll deductions and can be rolled over from year to year, like a 401(k). Bolstering the cost-control arsenal, insurers are reviving plans that offer narrow networks of providers.

Fresh on the heels of their exodus from the unprofitable Medicare+Choice program, insurers once again will be looking to expand their role in the Medicare program thanks to provisions in the new Medicare law.

C-suite scandals

Accused wayward executives will continue to face the legal music, most notably former HealthSouth Corp. Chairman and Chief Executive Officer Richard Scrushy, whose trial on 85 criminal accounts involving massive accounting fraud at the company is scheduled to begin Aug. 1 in Birmingham, Ala. Scrushy is accused of inflating HealthSouth's company income by $2.7 billion between 1996 and 2002.

Also awaiting trial are former McKesson Corp. Chairman Charles McCall and for-mer HBO & Co. general counsel Jay Lapine, although their cases may be stalled while a court decides whether to grant the defendants access to results of a McKesson internal investigation.

They are charged with recording fraudulent revenue that led HBO & Co. to restate earnings following its 1999 acquisition by McKesson, a San Francisco-based drug distributor. The merged business lost approximately $9 billion in market value after the restatement.

Federal investigators are circling in on top honchos of privately owned financing firm National Century Financial Enterprises, alleged to have bilked investors by siphoning more than $1 billion to risky investments. Two lower-level officials of the company already have pleaded guilty.

It also will be a critical year for Tenet Healthcare Corp. CEO Trevor Fetter says he wants to restore the No. 2 hospital chain's credibility with investors after multiple government investigations, yet there's also speculation that the government will force a breakup. Trial is slated on antikickback allegations that Tenet deliberately overpaid for physician practices to secure patient referrals to its North Ridge Medical Center in Fort Lauderdale, Fla. Criminal investigations at Tenet's Alvarado, Calif., hospital could also culminate in trials this year. Tenet recently agreed to sell its Redding, Calif., hospital after a federal threat to exclude it from participation in Medicare and Medicaid after allegations that the facility hosted unnecessary heart operations.

The corporate fraud crackdown and new legal risks for boards and executives imposed by the Sarbanes-Oxley corporate accountability law of 2002 may contribute to a continued slow market for initial public offerings, financial experts say. Despite investor interest in healthcare and a rising stock market, no healthcare companies so far have announced IPOs for this year. Only two healthcare-related companies--Medicaid HMO operator Molina Healthcare and social service provider Providence Service Corp.--went public in 2003. Investors also are pickier, looking for more sustained profitability and internal growth.

Linking pay and performance

The federal government at last is flexing its financial muscle to improve quality. Though it's investing a piddling $21 million over three years, the CMS inaugurates its pay-for-performance demonstration project with the Premier hospital alliance. Hospitals will receive bonuses for meeting quality-improvement goals in five areas, and data on the top half of performers will be released in October. By midyear, the CMS is expected to issue regulations spelling out what hospitals will have to do to qualify for extra Medicare reimbursement for reporting data on 10 quality measures for treatment of heart attacks, heart failure and pneumonia.

Also, on the safety front, it's the moment of truth for California's experiment with mandatory nurse-staffing ratios, which took effect Jan. 1. The industry will find out whether the ratios really improve patient safety as nursing groups claim, and whether they spell financial peril for hospitals, which fought the measure.

In the private sector, several regional consortiums of health plans are launching programs to reward providers financially to follow specified care standards. The Leapfrog Group, a consortium of large employers, this spring plans to accelerate its push for public reporting of quality statistics with a plan to score hospitals on safety standards. Starting this month, the Joint Commission on Accreditation of Healthcare Organizations strengthens its emphasis on quality and patient safety in giving its seal of approval to hospitals. Meanwhile, payer quality initiatives could prompt more hospital investment in clinical information systems.

Paul Keckley, executive director of the Vanderbilt Center for Evidence-based Medicine, expects some medical specialty societies--particularly those focusing on cardiology, family medicine, orthopedics and pediatrics--to begin promoting evidence-based medicine this year through continuing medical education and credentialing. He also predicts a ``full-court press'' to identify effective ways to manage obesity and increasing willingness by employers to fund chronic disease management as a way to temper costs. ``We know that employers have underspent on prevention and chronic disease management,'' Keckley says.

Hospitals: A capital struggle

Despite 2003's slowdown in inpatient utilization growth, most hospitals continue to plan for huge volume increases as baby boomers reach old age (July 28, 2003, p. 24).

Expect more talk of the capital gap--the difference between the amount of money hospitals will need to continue their growth and the amount they can raise from traditional sources such as bonds. The Healthcare Financial Management Association will release the last five of its series of six reports on the issue of capital access.

Meanwhile, financial advisory firms are boning up on nontraditional financing mechanisms such as those involving medical office buildings. Look for ``capital avoidance'' to become a catchphrase as more systems expand noncore businesses such as surgery centers through outsourcing arrangements and joint ventures with investor-owned companies.

Still, plenty of hospitals and healthcare systems will continue to tap the traditional bond market to fund capital projects that were deferred in the wake of the financial shock stemming from the Balanced Budget Act of 1997.

In fact, bankers at Citigroup expect new bond issuance to rise as much as 10% in 2004 despite an expectation that interest rates will rise and debt refinancing will diminish. That follows a 3.5% increase in the first 11 months of 2003 over the year- ago period.

Despite tighter covenants from investors, the issuance of tax-exempt healthcare bonds could be in for more growth in the future. Fred Hessler of Citigroup predicts a ``phenomenal'' construction wave starting in 2005 to replace hospitals built just after the launch of Medicare in 1965, continuing an already strong healthcare construction market.

That means many systems and hospitals will be making capital plans this year. ``Many systems are elongating the planning process,'' Hessler says.

Given rising need for capital, an uptick in mergers and acquisitions would be no surprise, particularly if Tenet implodes. Yet rural chains could see their acquisition pipelines dry up if Medicare reimbursement increases enable more rural not-for-profit hospitals to remain independent, says Frank Morgan, a healthcare analyst with Jefferies & Co.

On the legal front, hospital executives will be interested in reading the hospital retrospective study of previously consummated hospital mergers, which is due to be released by midyear. A key question is whether the ``lookback review'' will be a purely academic exercise in market and economic analysis or if the Federal Trade Commission will challenge its first hospital merger in more than five years.

Dealmakers also will be watching the tax trial of St. David's HealthCare System, Austin, Texas, which is partly owned by investor-owned HCA. If not delayed by a Supreme Court decision to hear the case, the case could dictate future governance arrangements for whole hospital and ancillary joint ventures between for-profits and not-for-profits.

Beyond specialty hospitals

The new federal moratorium on physician-owned specialty hospitals removes a threat to full-service acute-care hospitals in many markets. The 18-month moratorium affords general acute-care facilities time to gather evidence that could persuade Congress to enact a permanent ban in 2005.

``Acute-care hospitals are the 800-pound gorilla. Anyone who's going to fight (the ban on specialty hospitals) really is going to have an uphill battle,'' says Greg Miller, a senior vice president at Houlihan Lokey Howard & Zukin investment bank.

The question becomes, what will replace it? The rise of physician-owned specialty hospitals solidified the concepts of specialty centers of excellence and physician-directed management. Spurred by physicians' desires to augment their lagging incomes, hospitals are expected to continue partnering with physicians via management contracts and ancillary joint ventures that do not skirt federal law.

Still, more legal fallout is likely from the growing popularity of deals between hospitals and physicians. Experts expect more government settlements of alleged violations of the Stark Medicare antikickback statute, such as one last fall involving a Seattle urology group and a hospital accused of overpaying on a lithotriptor lease.

Physicians: Dwelling on rising costs

Despite easing concerns about reimbursement rates and malpractice insurance costs, physicians will continue to be absorbed by those issues. After winning a 1.5% increase in Medicare payments last year in place of what had been a scheduled 4.5% reduction, doctors are still struggling to make ends meet because of practice-expense costs that jumped about 8% in 2003, according to the Medical Group Management Association.

``In terms of payments, it will be a good year--relatively speaking,'' says William Jessee, president and CEO of the MGMA.

Fewer increases are projected in medical liability premiums. Some high-risk specialists were hit with increases of 50% or more last year, prompting some doctors to relocate, retire or restrict the scope of their practices. ``There's no reason to think there's going to be a radical reduction in malpractice costs,'' Jessee says, ``but I doubt that there are going to be the gigantic increases that hit in the last couple of years.''

But Larry Smarr, president of the Physician Insurers Association of America, says indicators point to continuing premium increases: ``All indicators point to continuing increases in premiums across the medical liability market in the coming year due to continued losses on malpractice claims and decreased yields on long-term bonds.''

``Although some states that have recently passed meaningful tort reforms will probably see smaller premium increases this year than those without--and possibly decreases in coming years--we won't see any widespread relief until federal legislation reining in excessive and unpredictable damage awards is passed,'' Smarr says.

Pressure for tort reform also is coming from the nursing home industry, especially in states where malpractice liability insurance is so expensive that some nursing homes are opting to go without coverage.

Supply-side economics

Expect competition to increase among group purchasing organizations as smaller competitors Broadlane and MedAssets continue to gain traction in the wake of a congressional inquiry that aired controversial business practices by behemoths Novation and Premier. Look for Novation to pressure lawmakers to put the same heat on other GPOs. Up for grabs is a $2.3 billion annual purchasing deal with the Greater New York Hospital Association, which will see its seven-year contract with Premier expire in June. Lee Perlman, president of GNYHA Ventures, a for-profit subsidiary that acts as the association's purchasing arm, says regardless of which company is picked, the GPO business model will migrate away from one-size-fits-all national contracts toward individual and regional contracts. ``I think that premise will cut across all GPOs,'' Perlman says.

Meanwhile, government scrutiny appears to be spreading to manufacturers. Perlman believes wholesalers and distributors will look for ways to expand their razor-thin margins following a consolidation wave. Distributors ``are watching manufacturers having huge profits and they are going to try very hard to change their business models,'' Perlman says. Along the same lines, Perlman predicts hospitals and distributors will pressure manufacturers to moderate their prices.

On the technology front, hospitals may soon see a price break on drug-eluting stents used in cardiac surgery. Boston Scientific Corp. is expected to get FDA approval early in the year for its new stent, eliminating a monopoly held by Johnson & Johnson. J&J's stent recently had a list price of $3,195.

--with Cinda Becker, Laura B. Benko, Vince Galloro, John Morrissey, Michael Romano and Mark Taylor

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