There’s a flurry of takeover transactions sweeping across the healthcare space. The sector’s key constituents are all seeking to grow in response to the confluence of market pressures set in motion by the Affordable Care Act.
Hospitals are merging and buying out providers. Doctors are consolidating into multi-specialty groups. Insurers are looking to link up and also acquire physicians.
Everywhere you turn, there’s an urge to merge in healthcare.
In many respects, it’s the 1990s all over again.
More than 105 hospital mergers occurred in 2012, up from about 50 to 60 annually from 2005 through 2007, according to a January report in the New England Journal of Medicine. That’s still almost half of the number of M&A transactions undertaken during the peak years in the late 1990s. (In 1997 alone there were 184[i] hospital M&A transactions.)[ii] But the trend is building.
The number of doctors employed by hospitals grew by 32 percent between 2000 and 2010, according to a 2012 survey by the American Hospital Association. By 2013, the majority of primary care physicians were employees instead of owners, according to a survey conducted by the American Medical Association. Almost 63 percent of pediatricians and 60 percent of family practice physicians were either employees or independent contractors.[iii]
The 1990s is the last time we saw this level of merger and acquisition activity. The average rate of hospital mergers doubled from 12 per year in the mid-1980s to 24 in the early 1990s, and then shot upward from there.
Declining Medicare reimbursement introduced with the Prospective Payment System, the advent of managed care, sweeping healthcare reform, along with a drop in demand for hospital beds (as more medical services shifted to the outpatient setting) all coalesced to spark a consolidation wave.
But a lot of those mergers also broke apart shortly after they were consummated. So why will today’s consolidation wave end any differently?
Mergers failed in the 1990s for a host of reasons, not least of which were the changes in the commercial and policy environment that altered reimbursement expectations.
A backlash to managed care constrained the capitated contracting that justified consolidation. Reimbursement cuts made owning doctors less profitable.
But a key factor was that the risk that providers were taking, under these capitated contracts, turned out to be poorly measured and providers lost money as a result.
Growth achieved through consolidation was supposed to enable providers to engage in global contracts. Providers took on the risk of caring for large patient populations, expecting to profit off of some of the savings realized once providers had an economic imperative to focus on cost and efficiency.
By the late 1990s, about one-third of physicians had contracts that paid them capitated rates for taking care of large patient groups. The money earned from these capitated contracts accounted for 21 percent of these doctors’ total revenue.
But in the end, measuring the risk of these arrangements (and properly pricing the contracts) wasn’t easy. Many newly-big provider groups lost a lot of money. Numerous hospital mergers were eventually unwound.
Will this time around be different?
Many in the industry say that hospitals and practice management companies overpaid for the doctor practices they acquired in the 1990s. Physician productivity also fell after these acquisitions, in part because reimbursement schemes didn’t take into account changing practice patterns once doctors turned from proprietors to personnel. These same mistakes, industry participants argue, won’t be repeated.[iv]
But chief among other factors is that, in the 1990s, the acquirers didn’t have the tools (or data) to properly measure the risk that they were taking on through these global contracts. Practice management companies were supposed to add this layer of sophistication. But that actuarial expertise was never adequately adopted and hospitals didn’t have ready access to the actuarial tools that were required.
Data on patient risk is now far more accessible, making it easier for providers to price capitated contracts. The tools for crunching these data sets are also readily available. And the actuarial skills required to conduct these analytics are more widely distributed across industry constituents and no longer the sole province of insurers.
Today, if a local hospital sees a lot of patients from a few of the community’s large employers, the hospital can compute the costs of approaching those employers directly, and signing global agreements with these self-insured businesses. Under Medicare, the data is generally even more readily available for conducting similar analyses.
But consolidating hospitals and provider groups must make the investments necessary to engage in these crucial analyses. In fact, this requirement should be a requisite factor of today’s M&A deals. And to address these requirements, we must have a vibrant market for entrepreneurial start-ups that cater to these needs.
As of yet, neither seems to have taken hold.
This time, things should be different. The market forces that have set in motion the current consolidation wave are hardly perched to reverse. Principal among these is a preponderance of capitated contracts that shift financial risk to providers.
But success also depends on learning from some of the flaws that stymied the last wave of mergers. This time, the urge to merge needs to be coupled with some sober thought around how providers intend to measure and understand the risk they’re taking on through these new arrangements, and how they plan to price it.
Patrick Pilch, CPA, MBA, is a Managing Director and the National Leader of BDO’s Healthcare Advisory practice and The BDO Center for Healthcare Excellence & Innovation. Dr. Scott Gottlieb is a practicing physician and Resident Fellow at the American Enterprise Institute. He advises BDO’s healthcare center.