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OCR for page 303
For-Profit Enterynse in Health Care. 1986.
National Academy Press, Washington, D.C.
Hospital Acquisitions arid Their Effects:
Florida, 1979-1982
Ka~ryn I. Brown and Richard E. Klosterrnan
The rapid emergence of investor-owned
hospital corporations as a major influence in
the provision of hospital care has been greeted
with both alarm and accolades (Relman, 1980;
Larson, 1983~. While much of this discussion
has been based on opinion or personal philos-
ophy, empirical evidence is becoming avail-
able on the similarities and differences between
investor-owned and not-for-profit hospitals, and
between system and nonsystem hospitals
(Lewin et al., 1981; Sloan and Vraciu, 1983;
and Pattison and Katz, 1983~. However, to date,
no studies have been published on the effects
of changes in ownership of hospitals. This study
examines hospital acquisitions in Florida in the
years 1979-1982.
New hospital construction has received sub-
stantial attention in the past due to the re-
lentless debate over the effectiveness of state
certificate-of-need legislation (Kushman and
Nuckton, 1977~. Hospital closures have re-
cently been the subject of a series of important
articles (Mullner et al., 1983~. However, the
characteristics of hospital acquisitions have re-
ceived only limited attention to date (Florida
Hospital Cost Containment Board, 1983~. This
paper will contribute to an understanding of
these issues by examining two major ques-
tions: (1) Prior to an ownership change, are
there significant differences between hospitals
that change ownership and other hospitals? (2)
After a change in ownership, are there signif-
icant differences in the behavior of hospitals
that experience an ownership change and other
Ms. Brown is the former director of research for He
Florida Hospital Cost Containment Board and is now
assistant executive director of the Edwin Shaw Hos-
pital, Akron, Ohio. Dr. Klosterman is associate pro-
fessor in the Department of Urban Studies, University
of Akron.
303
hospitals? Since 60 percent of the hospitals
that underwent a change in ownership in Flor-
ida between 1979 and 1983 were acquired by
investor-owned firms, these acquisitions re-
ceive detailed consideration.
RESEARCEI DESIGN
These questions are examined using data
from Florida for 1979 to 1982. Florida is an
appropriate study location due to the large
number of hospitals in the state (216 acute care
general hospitals in 1982), the high proportion
of investor-owned hospitals (approximately 35
percent), and the large number of recent
changes of hospital ownership (53 acute care
general hospitals between 1978 and 19831. In
addition, a unique data source is available
through the Florida Hospital Cost Contain-
ment Board (HCCB), a state hospital rate re-
view agency that has collected uniform hospital
data annually since 1979; data through 1982
were available at the time ofthis analysis. Most
of the analyses reported herein are for the 27
hospitals that changed ownership between 1979
and 1982 and for which HCCB data were avail-
able for all 4 years.
Data on several dimensions of hospital char-
acteristics are available for examining differ-
ences both before and after a change in
ownership between hospitals that had a
change in ownership and control hospitals that
did not. These include information on reve-
nues, profitability, sources of payment for pa-
tients treated, the efficiency of operations,
resources available for patient care, and the
hospital's regional characteristics. The 24 vari-
ables used to measure these dimensions are
summarized in Table 1.
Two major analyses were conducted. The
first used a cross-sectional design to compare
the characteristics of hospitals that experi
OCR for page 304
304
TABLE 1 Variables Used in the Analysis
FOR-PROFIT ENTERPRISE IN HEALTH CARE
Profitability
Operating margin pre-tax net operating revenue less expenses, as a percentage of pre-tax net operating
revenue.
Total margin after-tax net operating and nonoperating revenues less expenses as a percentage of net
operating revenue.
Types of Patients Treated
Percent Medicare patients Medicare acute care patient days as a percentage of total acute care patient
days.
Percent Medicaid patients Medicaid acute care patient days as a percentage of total acute care patient days.
Percent charity and bad debt patients-deductions from revenue due to bad debt and charity patients as a
percent of total patient care revenues.
Efficiency of Operations
Operating expense per adjusted admission a ratio of total operating expense and total adjusted admissions.
Percent occupancy- hospital utilization based on acute licensed beds and acute patient days.
Average length of stay (ALOS) a ratio of total acute patient days and total acute admissions.
Salary expense per adjusted admission a ratio of total personnel expense and adjusted admissions.
Salary per full-time equivalent employee-the average employee's salary.
Man-hours per adjusted patient day the number of employee hours per average adjusted patient day.
Revenues
Gross revenue per adjusted admission total patient charges for an average admission.
Net revenue per adjusted admission the average amount of revenue the hospital receives for an average
. . .
aamlsslon.
Ancillary revenue per adjusted admission average patient charges for services not covered in the room
charge.
Available Resources
Number of licensed beds a direct measure of hospital size.
Service index score-a weighted index based on the presence or absence of 21 services and with a maximum
score of 81.3. (See Appendix A for additional details.)
Physician-mix score-an unweighted index based on the presence or absence of 24 physician specialties and
with a maximum score of 24. (See Appendix B for additional details.)
Percent patient care salary expense Me proportion of personnel resources devoted to direct patient care.
Number of residents the number of residents in hospitals with approved residency programs.
Regional characteristics
Per capita income a ratio of total county income to total county population in 1980.
Percent over 65 a ratio of total county population over 65 to total county population in 1980.
Number of hospitals in county-the number of acute care general hospitals in the county.
Number of physicians in county- a ratio of active physicians in the county to the total county population
divided by 1,000.
Geographic puce level index county level index score developed by the Flonda Hospital Cost Containment
Board and based on the Flonda Price Level Index and data reported to the board.
enced a change of ownership with hospitals
that did not. The second used a longitudinal
design to compare the behavior of hospitals
after a change in ownership with the behavior
of hospitals that did not change ownership.
The cross-sectional analysis compared the
characteristics of the hospitals that expe~i-
enced an ownership change between 1979 and
1982 to the characteristics of hospitals that did
not. The analysis was performed on data for
1979 at two levels of aggregation. The first
analysis compared 27 hospitals that changed
OCR for page 305
EFFECTS OF ACQUISITIONS
ownership in 1979, 1980, and 1981 to 168 hos-
pitals that did not. (The remaining acute care
hospitals were excluded because of incomplete
reporting.) The second analysis focused on
hospitals purchased by the most actively ac-
quiring sector of the industry investor-owned
chains. Hospitals acquired by investor-owned
chains were partitioned into those that changed
hands when one corporation acquired another
corporation (and the hospitals that it owned)
and those that were acquired individually. The
analysis examines how both types of acquired
hospitals differed from other hospitals, and
whether the nature ofthe acquisition (i.e., cor-
porate takeover or individual purchase) af-
fected the results. Additional analysis compared
the hospitals already owned by investor-owned
chains to the hospitals they acquired during
that period.
The longitudinal analysis compared rates of
change in the institutional variables in Table
1 for the acquired and comparison hospitals
between the pre-acquisition period, 1979, and
the post-acquisition period, 1982. The regional
characteristics were omitted from this analysis
because they did not change significantly dur-
ing this period. The longitudinal analysis was
conducted for the total populations of hospitals
that did and (lid not undergo an ownership
change and for each of the subcategories of
hospitals acquired by investor-owned chains.
The cross-sectional and longitudinal anal-
yses used the student's t statistic to test for
significant differences between the mean val-
ues for hospitals that changed ownership and
comparison hospitals that did not. The total
population of 27 cases of hospital ownership
changes is rather small for statistical testing.
Partitioning by ownership category further re-
duces the sample sizes. As a result, variables
that are found to be statistically significant in
this stuily are particularly important.
DESCR~ON OF HOSPITALS THAT
CHANGED OWNERSHIP
Fifty-three acute care general hospitals
changed ownership in Florida during the pe-
riod between 1978 and 1983 (see Table 21.
Seventy-nine percent ofthese were due to for-
profit organizations acquiring for-profit hos-
pitals. Thus, while a reconfiguration ofthe hos
305
TABLE 2 Hospital Acquisitions in Florida,
1978-1983
Year
Number of Acute Care
General Hospitals
978
979
980
981
982
983
Tonsil
6
7
0
3
4
3
53
pital industry was supposedly occurring, most
change was occurring in one sector of the in-
dustry. The number of ownership changes in-
creased each year between 1978 and 1982 and
sharply decreased in 1983. It is likely that the
introduction of prospective Medicare reim-
bursement and the accompanying uncertainty
affected the number of acquisitions in that year.
As Table 3 demonstrates, the hospitals that
underwent an ownership change were quite
diverse. They ranged in size from 27 to 771
licensed beds; in service index scores from 12
to 62; in Medicare caseloads from 18 to 74
percent; in Medicaid caseloads from O to 48
percent, and in total margins from - 54 per-
cent to 9 percent.
Most ownership changes took place in sec-
tions of the state that are characterized by sea-
sonal populations or tourists. Southeast Florida,
which includes Miami, had 37 percent of the
ownership changes. Northwest Florida, which
is less densely populated and has fewer sea-
sonal residents, lower income levels, and fewer
elderly, had the smallest percentage, 11 per-
cent.
Table 3 also demonstrates that most of the
hospitals that underwent an ownership change
were investor-owned both before (74 percent)
and after (81 percent) the change. Investor-
owned chains were the most active acquiring
organizations, making almost 56 percent of the
acquisitions. A single firm (Hospital Corpo-
ration of America) accounted for 73 percent of
the purchases by investor-owned chains.
Investor-owned chains also owned more than
half (8 of 15) of the hospitals acquired by other
chains; 40 percent of the hospitals acquired by
chains were previously independent investor
OCR for page 306
306
FOR-PROFIT ENTERPRISE IN HEALTH CARE
TAIL 3 1979 Characteristics of Acquired Hospitals
Charactenstic Mean Range
Number of licensed beds 192.3 27.0-771
Service index (see Table 1) 21.7 11.9-62.5
Physician mix (see Table 1) 15.9 3.0-24
Number of residents 15.1 0.0-368
Percent Medicare patients 44.9 17.9-74.1
Percent Medicaid patients 7.6 0.0 48.2
Average length of stay (days) 7.1 4.0-9.2
Percent occupancy 62.5 19.~92.4
Operating margin (percent) 1.85 -73.~14.9
Total margin (percent) 0.76 - 54.7-9.1
Acquired hospitals with management contracts: 25%
Locations Number Percent
Northwest Florida 3 11.1
Southeast Flonda (6 in Miami) 10 37.0
West Coast of Florida 7 25.9
Central and Northeast Florida 7 25.9
Total 27 100.0
Changes in Organizational Form Number Percent
Government to-
Not-for-profit 4 14.8
Not-for-profit to-
Not-for-profit 1 3.7
Independent investormwned 1 3.7
Chain investor-owned 1 3.7
Independent investor-owned to
Independentinvestor-owned 6 22.2
Chain investor-owned 6 ~.2
Chain investor-owned tom
Chain investormwned 8 29.6
Total 27 100.0
owned hospitads. Only one not-for-profit hos-
pital was acquired by an investor-owned chain.
Table 4 provides additional background on
the hospitals that changed ownership by com-
paring them with other hospitals according to
their pre~har~ge (1979) type of ownership. The
three not-for-profit hospitals that underwent a
change of ownership were dramatically smaller
and less complex than other not-for-profit hos-
pitals and other hospitals that changed own-
ership.
Government-owned hospitals whose own-
ership did not change were notable in their
low percentage of Medicare patients and high
Medicaicl caseloads, and this pattern was par-
ticularly true for the four government hospitals
that subsequently changed ownership. All four
government hospitals that changed ownership
became not-for-profit hospitals. In addition,
these four hospitals were, on average, larger
and more complex than other government hos-
p*als as well as other hospitals that changed
ownership. They included the two largest hos-
pitals in the study as well as two of the small-
est. All four of these hospitals were located in
counties with low per capita income levels.
Investor-owned chain hospitals that under-
went a subsequent change of ownership had
much higher Medicaid caseloads and lower
Medicare case loads than did investor-owned
hospitals whose ownership did not change.
The independent investor-owned hospitals
that did not change ownership had notably low
occupancy levels in 1979, although this had
OCR for page 307
EFFECTS OF ACQUISITIONS
changed by 1982. They also were located in
areas of unusually high per capita income lev-
els and high elderly concentrations. The in-
dependent investor-owned hospitals that
changed ownership (almost 50 percent of all
independent investor-ov~ned hospitals) were
operating at more typical occupancy levels and
in areas of more modest income levels and
average elderly concentrations.
Thus, there were several differences among
hospitals in the pre-acquisition period. Not-
for-profit hospitals that subsequently changed
ownership were small and unsophisticated. The
acquired government hospitals that under-
went an ownership change were on average
larger, more complex, and had smaller Med-
icare caseloads than other government hos-
pitals and other hospitals that had an ownership
change. Investor-owned hospitals, both chain
and independent, that subsequently changed
ownership had higher Medicaid and lower
Medicare levels than other investor-owned
hospitals, although their levels were about av-
erage for hospitals that underwent a change in
ownership. These differences are examined
Farther in the following section.
ANALYSIS OF PRE-ACQUIS11101
CHARACTERISTICS
Are hospitals that change ownership differ-
ent from those that do not? It seems unlikely
that organizations motivated by profit max-
imization, status enhancement, medical staff
satisfaction, community interest, or any of the
other objectives that have been attributed to
hospitals (e.g., White, 1979) would randomly
select facilities for acquisition or that random
facilities would be available for acquisition.
Possible acquisition objectives range from public
service efforts such as saving a distressed hos-
pital, to protecting market position by pre-
venting new competition from entering the
area, to gaining access to growing markets, to
bed banking (the purchase of a hospital to en-
able the parent facility to trade some portion
of those beds for a certificate of need) (Gersh,
1982~. Possible objectives for corporate reor-
ganization include enhancement of reimburse-
ment, reductions in government regulation,
and improved compensation for top executives
(fillet et al., 1982).
307
For investor-owned companies, a most com-
pelling rationale is undoubtedly the search for
increased levels of profitability, consistent with
overall goals for the parent firm. This suggests
that the attractive acquisition candidate would
have either good profitability or the potential
for increases in profitability and that steps would
be taken after the acquisition of a hospital to
improve profit levels. Possible avenues avail-
able for increasing the profitability of an ac-
quired institution include changing the patient
mix by source of payment, improving the ef-
ficiency of operations (including increased vol-
ume), increasing price levels, and realigning
the resources available for patient care. The
profitability of the acquired hospitals and the
potential for improving these profits through
each of the avenues is considered in the fol-
lowing section.
Profitability
The data in Table 5 indicate that the total
population of hospitals that underwent an
ownership change had unusually low profit
levels in the pre-acquisition period. Both op-
erating margin and total margin were below
those for other hospitals. For total margin the
difference is statistically significant at the .10
percent level.
Table 5 also reveals that hospitals acquired
by investor-owned chains had lower total mar-
gins but higher operating margins than the
total population of hospitals that did not change
ownership. This reflects the fact that operating
margin is a pre-tax measure that includes rev-
enues eventually paid as taxes by for-profit
institutions. In comparison to investor-owned
hospitals whose ownership did not change,
these operating margins are low (see Table 5~.
Ibus, the hospitals acquired by investor-owned
chains conform to the general finding of low
pre-acquisition margins, especially in compar-
ison to existing investor-owned hospitals, de-
spite the fact that the levels of these margins
were higher than for other hospitals that
underwent an ownership change.
Types of Patients Treated
The makeup of a hospital's patient popula-
tion by source of payment can have a direct
OCR for page 308
308
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impact on overall profitability. From a reim-
bursement standpoint, patients can be ranked
with respect to the portion of their charges
that will actually be paid. Insured charge-pay-
ing patients are most likely to reimburse the
hospital fully, followed in order by Medicare
and Medicaid patients who pay allowable costs
rather than full charges. Bad debt and charity
cases are least desirable because their charges
must be written off (although in some cases
public funds may help offset the losses). As a
result, hospitals with a sizable charity and bad
debt burden are likely to have low profit levels
or even losses and comparatively high charges
because paying patients must subsidize pa-
tients receiving uncompensated care.
In 1979, hospitals in Florida wrote off 7.4
percent of assessed charges to charity care and
bad debts. For government hospitals, which
have played a major role historically in pro-
viding this kind of care, the figure was 14.2
percent. A hospital that can modify its patient
mix to increase the proportion of Medicare and
fully insured patients can improve its profit
levels without changing its charges or costs.
Improved collections of bad debts can also re-
duce the percentage of cases attributed to that
category and improve profits, if collection costs
do not exceed revenues.
The results in Table 5 suggest that the hos-
pitals that subsequently changed ownership
had the potential for changes in patient mix
since their Medicaid caseloads and their char-
ity and bad debt level were higher than those
of other hospitals. In addition, the Medicare
caseload for the hospitals whose ownership
subsequently changed was comparatively low.
Hospitals that investor-owned chains sub-
sequently acquired deviated from this pattern
with bad debt and charity write-offs that were
low compared to the total population of hos-
pitals whose ownership did not change. How-
ever, bad debt and charity figures were
nevertheless higher than for He investor-owned
hospitals whose ownership remained un-
changed (see Table 51. Hospitals acquired in-
dividually by the investor-owned chains also
had extremely low Medicaid caseloads (al-
though above average for investor-owned hos-
pitals) and comparatively high Medicare case
loads (average for investor-owned hospitals).
Thus, from a reimbursement standpoint the
FOR-PROFIT ENTERPRISE IN HEALTH CARE
patient mix of hospitals acquired individually
by investor-owned chains was particularly de-
sirable.
Efficiency of Operations
Profit levels can be enhanced by reducing
expenses, for example, through reductions in
staffing levels, or by increasing volume with-
out commensurate increases in expenses. The
data in Table 5 suggest that some potential for
efficiency improvements existed among hos-
pitals that subsequently underwent a change
of ownership. Operating expenses per ad-
justed admission were slightly higher for such
hospitals, even after adjustments were made
for differences in hospital input prices and de-
spite the fact that hospitals whose ownership
changed had a slightly lower case-mix score
than other hospitals (as measured by the Health
Care Financing Administration's case-mix score
based on 1980 data). Some sources of these
higher expenses In be identified. Occupancy
levels were slightly lower. And because staB-
ing levels and salary expense per adjusted ad-
mission were lower, the hospitals whose
ownership changed must have had higher non-
salary expenses. The hospitals subsequently
acquired by investor-owned chains had the
highest levels of operating expense per ad-
mission of all hospitals that changed owner-
ship. Expenses other than salaries were the
primary source of this differential.
Revenues
The data in Table 5 reveal that hospitals
whose ownership subsequently changed had
higher average revenues and collected more
per adjusted admission than did other hospi-
tals in 1979. Their ancillary revenues were also
higher. Since markups are typically higher on
ancillary services than on room services, this
indicates that charges for the hospitals that
were subsequently acquired were already rel-
atively high for the more profitable portion of
the patient bill.
The hospitals subsequently acquired by
investor-owned chains mirrored the general
pattern, although their revenues were higher
than average for hospitals that underwent a
subsequent ownership change. Again, hospi
OCR for page 313
EFFECTS OF ACQUISITIONS
tats subsequently acquired individually by
investor-owned chains had the most desirable
revenue profile with the highest average net
revenue per admission.
Available Resources
Also important to hospital growth and long-
term profitability is the range of resources
available for patient care particularly the
medical staff profile. Physicians are the gate-
keepers for any hospital, determining that a
hospital admission is necessary and advising
patients on where they should be admitted.
Without a minimal number of physicians and
a core of medical specialties, it may be difficult
to compete for patients. On the other hand,
certain physician specialties tend to admit
complex cases that are costly to treat. De-
pending upon the reimbursement sources for
these patients, overall profitability may be af-
fected.
The range of services that a facility offers is
also important. Certain resources are essential
to attract or keep particular physician special-
ties and their patients, even though they may
increase costs. Hospitals must deal with these
frequently conflicting considerations in light
of their own definition of the hospital's mis-
sion. Management strategies focused on profit
maximization could expand into new clinical
areas that have potential for reasonable levels
of returns, or attempt to perform better with
the existing mix of services, or eliminate un-
profitable services.
The results in Table 5 suggest that the hos-
pitals that had a subsequent change of own-
ership were only marginally smaller and less
complex than other hospitals in 1979. Their
physician-mix score was slightly lower. The
hospitals subsequently acquired by investor-
owned chains followed the general pattern for
available resources with the exception of phy-
sician mix, where their physician-mix scores
were slightly higher than the average for all
hospitals, but slightly below average for inves-
tor-owned hospitals whose ownership did not
change (see Table 5~.
Regional Characteristics
The potential for improvements in profits
can also be affected by a hospital's location.
313
Locations in affluent areas or in areas with
large elderly populations may have greater po-
tential for volume growth and revenue en-
hancement than do locations in low-income
areas where there are larger numbers of un-
insured people. Locations with relatively large
numbers of physicians and few competing hos-
citals also have greater potential for devel-
oping the desired medical staffprofile. Finally,
hospitals located in regions with lower input
prices should be able to operate at lower cost,
other things being equal.
The data in Table 5 reveal that per capita
income levels and the number of physicians
in the county were higher in 1979 for the hos-
pitals that underwent a subsequent ownership
change, but elderly populations were more
prominent in the area of hospitals whose own-
ership remained unchanged. In addition, the
hospitals that subsequently changecl owner-
ship were generally located in areas with com-
paratively high input prices (actually above the
state average) and an above-average number
of facilities. Hospitals subsequently acquired
by investor-owned chains through corporate
takeovers mirrored the regional pattern for
hospitals that underwent an ownership change.
Hospitals acquired individually were different
in several important ways. Most dramatic was
the high elderly concentration in the counties
where these facilities were located. These con-
centrations undoubtedly accounted for the high
Medicare caseloads noted above and are con-
sistent with typical locations of other investor-
owned hospitals in Florida. Also noteworthy
is the smaller average number of acute care
general hospitals in the counties where these
facilities were located. Thus, the individually
acquired facilities again had a particularly de-
sirable profile.
Overall Characteristics of Hospitals That
Subsequently Changed Ownership
In conclusion, the hospitals that subse-
quently underwent an ownership change dif-
fered Dom other hospitals in several important
ways. They had significantly lower total profit
margins, which were not due to lower charges
(their charges were actually slightly higher)
but to slightly higher operating costs, fewer
admissions, and the more frequent necessity
OCR for page 314
314
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OCR for page 315
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OCR for page 316
316
of paying taxes out of profits. Although slightly
smaller and less complex than other hospitals,
the hospitals that subsequently changed own-
ership had higher costs and a less desirable
patient mix with more Medicaid patients and
more bad debt and charity. While only the
low total margin and high Medicaid caseload
measures were statistically significant, the
findings suggest both why these hospitals might
have been candidates for being sold and what
types of management strategies might have
been expected to increase their profitability
after acquisition.
Hospitals subsequently acquired by inves-
tor-owned chains (and particularly those ac-
quired individually) had a more desirable profile
in the pre-acquisition period (e. g., higher mar-
gins and better patient mix for reimbursement
purposes) than the acquired hospital that
underwent a subsequent ownership change.
As a result, the magnitude of post-acquisition
change in these facilities may well be less dra-
matic than might otherwise occur because their
starting point was relatively favorable.
ANALYSIS OF POST-ACQUISITION
BEHAVIOR
Hospital behavior in the post-acquisition pe-
nodwas examined by comparing rates of change
for the acquired and other hospitals (i.e., those
whose ownership was unchanged) between 1979
and 1982 for most of the measures noted in
Table 1. The five regional variables were not
examined because they did not change signif-
icantly in the 3-year period. Again compari-
sons were made between the total population
of hospitals that had an ownership change and
the total population of hospitals acquired by
investor-ownec] chains, whose ownership did
not change.
The analysis of the pre-acquisition charac-
teristics revealed that the hospitals that had
an ownership change had consistently lower
profit levels than the other hospitals, which
may explain why they were available for ac-
quisition. Several possible approaches for in-
creasing the profitability of acquired hospitals
were proposed including: changing the patient
mix, improving the efficiency of operations,
increasing revenues, and realigning available
resources. The actual changes experienced in
FOR-PROFIT ENTERPRISE IN HEALTH CARE
the post-acquisition period are discussed in
the following section.
Profitability
The data in Table 6 reveal that the profit
margins for the hospitals that underwent an
ownership change increased dramatically faster
between 1979 and 1982 than they did for the
hospitals whose ownership did not change.
Operating margins for the hospitals whose
ownership changed increased at a rate of over
200 percent in the 3-year period, compared to
approximately 38 percent for other hospitals.
During this period average total margin for the
hospitals whose ownership changed increased
by over 400 percent compared to less than 25
percent for other hospitals. Even so, these in-
creases brought the average total margin of
hospitals whose ownership changed to 4.16
percent in 1982, a level still below the 5.38
percent total margin for hospitals whose own-
ership had not changed.
The hospitals acquired by investor-owned
chains expenenced less dramatic increases in
margins than did other hospitals that changed
ownership, partially because of their compar-
atively high margins in the pre-acquisition pe-
riod. Hospitals acquired through corporate
takeovers had rates of increase that were ac-
tually less than in hospitals with unchanged
ownership, as a result, total margins in 1982
for these facilities were lower than those for
either the average hospital that had changed
ownership or the average hospital whose own-
ership had not changed. Hospitals acquired
individually by investor-owned clinics achieved
more substantial rates of increase in margin
and as a result in 1982 exceeded the operating
margin and equaled the total margin of the
average hospital that had not changed own-
ership. Even with those substantial rates of
increase, their average margins were less than
those of the average investor-owned hospital
whose ownership had not changed.
Types of Patients Treated
Significant post-acquisition changes took
place in patient mix, with the percentage of
revenues written off to charity and bad debt
diminishing on average almost 20 percent in
OCR for page 317
EFFECTS OF ACQUISITIONS
hospitals that underwent an ownership change
while they increased by more than 5 percent
for other hospitals. This difference is signifi-
cant at the .01 percent level. It should be noted
that the absolute dollar amount written off by
hospitals that underwent an ownership change
increased in this period, but at a slower rate
than the increase in average charge per ad-
mission. These figures suggest that the aver-
age number of bad debt or charity cases that
could have been treated actually decreased even
though the dollar amount written off in-
creased.
Medicare caseloads for hospitals that under-
went an ownership change increased at a rate
nearly twice that for other hospitals and almost
equalized levels between the two categories
of hospitals. This difference was also statisti-
cally significant. Medicaid caseloads increased
less than three-tenths of 1 percent for the hos-
pitals that changed ownership and by almost
5 percent for other ones. These increases still
did not eliminate the dramatic difference in
Medicaid caseloads that existed in 1979 be-
tween hospitals that changed ownership and
those that did not. In sum it appears that the
hospitals that changed ownership changed their
patient mix in the post-acquisition period to
reduce their clependence on less reliable rev-
enue sources and to increase the proportion
of patients with more reliable reimbursement.
The hospitals acquired by investor-owned
chains mirrored the general pattern of reduc-
tions in the percentage of revenue written off
to bad debt and charity care, despite the fact
that these facilities had comparatively low bad
debt and charity writeoffs in the pre-acquisi-
tion period. Consistent with Me general pat-
tern, Medicare caseloads increased both
absolutely and as a percent of all cases for both
types of hospitals acquired by investor-owned
chains, although the individually acquired fa-
cilities, which already had unusually high
Medicare caseloads, expenenced smaller in-
creases. Medicaid caseloads actually de-
creased (both as a proportion and in absolute
numbers) for the hospitals acquired under cor-
porate takeovers. The Fanatic increase in
Medicaid caseload for the hospitals acquired
individually reflects both the low levels in the
pre-acquisition period and a sizable increase
for one of these seven facilities. With the ex
317
ception of this one hospital, the hospitals ac-
quired by investor-owned chains continued to
improve their patient profile from a reim-
bursement standpoint. The hospitals acquired
individually had a less dramatic change, prob-
ably because of their comparatively desirable
patient profiles in the pre-acquisition period.
Efficiency of Operations
While efficiency improvements and result-
ing cost reductions are frequently cited ex-
pectations for hospital acquisition, expenses
increased faster for the hospitals that under-
went an ownership change than for other hos-
pitals. Occupancy levels and the number of
admissions also increased at much slower rates
than for the hospitals whose ownership was
unchanged (significantly slower for occupancy
levels). Personnel costs increased at approxi-
mately the same rate for both groups of hos-
pitals, indicating that the nonsalary components
of expense were the primary cause of the dif-
ferent rates of increase in overall operating
expense.
Although the data do not make it possible
to deter~nine exactly which components of the
nonsalary expenses caused these changes, the
findings of an earlier study on acquired hos-
pitals in Florida (Florida HCCB, 1983) iden-
tified several potential sources. That study
(based on some of the hospitals included in
this study) attributed above-average increases
in operating expense by acquired hospitals to
high interest expense associated with high lev-
els of debt financing, high depreciation ex-
pense associated with the rapid increase in
asset value upon acquisition, and in at least
one case, high rental expenses paid to related
parties. The finding here that nonsalary ex-
penses contributed at above-average levels to
expense increases is consistent with these ear-
lier findings.
The hospitals acquired by investor-owned
chains exhibited faster rates of increase in ex-
penses than did all hospitals whose ownership
was unchanged and than did investor-owned
hospitals whose ownership did not change (see
Table 6~. These increases were in addition to
their comparatively high expense levels in the
pre-acquisition period. Expense increases for
hospitals acquired during corporate takeovers
OCR for page 318
318
were statistically significant. As in the general
case, nonsalary expenses contributed dispro-
portionately to these increases in expense lev-
els.
Revenue
All measures of revenue showed faster rates
of increase for the hospitals that changed own-
ership than they dicl for other hospitals. The
net revenue figure reflects not only increases
in charges, but also the modifications in pa-
tient mix by reimbursement category pointed
out above. The dramatic increase in ancillary
revenue suggests that increases in the number
of ancillary services provided and/or in the
charges for ancilBary services contributed sig-
nificantly to the increase in revenues.
The hospitals acquired by investor-owned
chains exhibited increases in revenues which,
with one exception, exceeded the average
changes for hospitals that had an ownership
change. Gross revenue per adjusted admission
increased somewhat slower for individually ac-
quirec! hospitals than for hospitals whose own-
ership did not change. The rate of increase on
net revenue was significantly higher for the
hospitals acquired under corporate takeovers
than for hospitals that did not change owner-
ship. It appears that despite comparatively high
revenue levels in the pre-acquisition period,
the hospitals acquired by investor-owned chains
(and particularly those acquired under cor-
porate takeovers) experienced unusually high
revenue increases after acquisition.
Available Resources
Virtually no changes were observed in the
average service mix of hospitals that under-
went an ownership change. Increases in their
physician-mix index exceeded the rate for other
hospitals. This suggests that the acquired hos-
pitals attempted to attract new patients by
adding new physician specialties. This fading
is consistent with the modifications in patient
mix that occurred during the period.
The hospitals acquired by investor-owned
chains under corporate takeovers experienced
modest rates of increase in the physician-mix
index and decreased their service index score
in the post-acquisition period. Those acquired
FOR-PROFIT ENTERPRISE IN HEALTH CARE
individually increased both their service index
and physician-m~x scores at rates faster than
those for other hospitals.
Overall Changes in the Post-Acgliisidon
Period
The findings reveal that the profitability of
hospitals whose ownership changed dramati-
cally increased in the post-acquisition period.
This was accomplished by modifying their pa-
tient mill, increasing revenues (especially an-
cillgry revenues), and attempting to enter new
patient markets. Improved efficiency was not
a contributing factor as operating expenses for
these hospitals actually increased faster than
they did for hospitals whose ownership was
unchanged.
The post-acquisition behavior of the hospi-
tals acquired by investor-owned chains was also
substantially different from the behavior of
hospitals whose ownership was unchanged. The
pre-acquisition characteristics of these hospi-
tals may explain many of these differences.
Hospitals acquired Trough corporate take-
overs followed the general pattern for all hos-
pitals whose ownership changed, but at faster
rates. The major exception was that profit mar-
gins, which were comparatively high in 1979,
increased at comparatively modest rates in the
post-acquisition period. Hospitals acquired in-
dividually by investor-owned chains had com-
paratively high margins and a fairly desirable
patient profile in the pre-acquisition period,
so post-acquisition increases were smaller than
increases for other hospitals whose ownership
changed, though these increases still generally
exceeded Hose for the hospitals whose own-
ership was unchanged.
DISCUSSION
The observed differences between hospitals
that eypenenced an ownership change and over
hospitals in Florida raise several interesting
policy issues. Primary among these is the issue
of profitability itself. The study reveals that
the hospitals that changed ownership had sig-
nificantly lower profit margins than other hos-
pitals prior to the ownership change. The 1979
average total margin for hospitals that subse-
quently changed ownership was 0.76 percent,
OCR for page 319
EFFECTS OF ACQUISITIONS
a very low figure compared to margins for the
average hospital in the state or for other in-
dustries. Ibe often-cited capital crisis of the
1980s and the resulting fierce competition for
capital will require an ongoing accumulation
of profits if hospitals are to engage successfully
in the major capital expenditures which even-
tually face all institutions. From this stand-
point the acquisition process may be extremely
beneficial in substantially improving margins
for hospitals that have been unable or unwill-
ing to generate necessary and healthy margins.
The study reveals that overall increases in
profit levels for hospitals that changed own-
ership in the 3-year period were dramatic; op-
erating margins increased by an average of more
than 200 percent and average total margins
increased by over 400 percent. As a result,
average profit margins for the 27 institutions
reached a level of 4.16 percent in 1982. How-
ever, the range in these margins (from 15.9
percent to -44.5 percent) suggests that these
hospitals did not benefit uniformly from the
change in ownership.
The profitability experience of the hospitals
acquired by investor-owned chains was less
dramatic but also exhibited much variability.
In the 3-year period between 1979 and 1982,
5 ofthe 15 hospitals acquired by investor-owned
chains had reached margins that were average
for that comparatively profitable sector, and 2
others had margins that exceeded the average els.
for hospitals that had not changed ownership. - ~ ~
However, 2 of the 15 hospitals acquired by
investor-owned chains had negative margins
in 1982. Thus, these findings do not provide
strong support for the argument that acquisi
tion by investor-owned hospitals will lead to
excessive profiteering. On the other hand, the
fact that some facilities achieved substantial
after-tax margins (the high was 10.8 percent)
when pre-acquisition levels were low or neg
ative suggests that the concern cannot be to
tally dismissed.
Perhaps of more concern Man profitability
are the social effects of the management strat-
egies that the acquiring firms used to increase
profit margins. Intentionally or not, the hos-
pitals whose ownership changed previously
served as a major source of Medicaid, bad debt,
and charity care. While these categories of pa-
tients may not be desirable from a reimburse
319
ment standpoint, as the most needy segment
of society they clearly require access to the
hospital system. However, the hospitals whose
ownership changed collectively reduced bad
debt and charity and held Medicaid increases
to a minimum.
For the hospitals acquired by investor-owned
chains the findings are similar, showing re-
ductions in Medicaid and bad debt and charity
burdens in facilities that generally were al-
ready low on these measures. Some of the
reduction in bad debt may have resulted from
improved collection techniques rather than
through reductions in access to care; however,
the fact that in the same period the hospitals
whose ownership did not change had an in-
crease in bad debt and charity raises the pos-
sibility that some of the reduction may have
been accomplished by channeling these pa-
tients to other facilities.
Also troubling is the finding that hospital
acquisition is a cost-inducing process. Un-
doubtedly some of the increased expenditures
were necessary and would have occurred in
any case. However, some earlier evidence is
available to suggest that a significant portion
of these cost increases was a result of the fi-
nancing strategies and operating arrangements
employed by the acquiring firms. Such cost
increases do not lead to significant improve-
ments in operating efficiencies or service lev
For the hospitals acquired by investor-owned
chains, these same concerns apply perhaps more
strongly since it is for this sector ofthe industry
that the benefit of operating efficiency is so
often claimed. The rapid increases in operat-
ing expenses on top of unusually high levels
in the pre-acquisition period call that claim
into question.
A direct consequence of the escalation in
expenses due to hospital acquisition was a siz-
able increase in patient charges. A major source
of the improved profitability for the hospitals
that underwent an ownership change was the
increased price of an admission. In cases where
facilities were operating at a loss, this may have
been an essential management step. However,
in cases where revenues were already high,
the necessity for Farther increases can be ques-
tioned.
This last concern is particularly appropriate
OCR for page 320
320
for hospitals acquired by investor-owned chains.
Post-acquisition revenues for these facilities
increased faster than expenses; as a result,
margins increased. The result of acquisition
by investor-owned chains included, among
other things, dramatic increases in charges that
were already comparatively high.
It should be noted that revenue increases
for hospitals acquired individually by investor-
owned chains were less dramatic than those
for hospitals acquired under corporate take-
over. It is perhaps not surprising that these
facilities, which had been individually selected
for acquisition, could achieve increased mar-
gins with less dramatic increases in charges
and could modify operations with less dramatic
increases in expenses. It is not clear if this
pattern can be maintained as fewer "desirable"
acquisition candidates remain.
The fact that facilities acquired under cor-
porate takeovers had such dramatic increases
in expenses and revenues is also understand-
able. Decisions regarding these acquisitions
were made on the basis of larger considera-
tions than the characteristics of a few hospitals
in Florida. The number of facilities involved
in these takeovers nationally would make it
difficult to modify operations quickly and ef-
ficiently. Likewise the amount of debt neces-
sitated by these takeovers could have a direct
effect on interest and depreciation expenses.
Regardless of the reasons, the consequences
were dramatic. This study's findings suggest a
serious concern with the impact of corporate
takeovers on system costs and resulting patient
charges.
The introduction of prospective reimburse-
ment under Medicare wiB undoubtedly affect
future decisions concerning hospital acquisi-
tions and We behavior of those facilities after
acquisitions. The incentives under the new
system for reducing costs and service utili7~-
lion and for promoting the provision of care
in profitable diagnostic categories will proba-
bly change significantly the behavior of indi
FOR-PROFIT ENTERPRISE IN HEALTH CARE
vidual hospitals and corporate chains. This study
suggests Mat the effects of hospital acquisition
deserve thorough study in the years ahead. If
existing patterns of increased charges and ex-
penses and reduced provision of care to in-
digents continue under that system as well,
the hospital acquisition process may help con-
~ibute to a reconfigured hospital system that
is less responsive to society's needs.
REFERENCES
Gersh, David L. (1982) Hospital acquisitions de-
mand caution. Modern Healthcare 12:94 96.
Florida Hospital Cost Containment Board (HCCB)
(1983) Impact of Acquisition on Hospital Finances. Un-
published manuscript.
Kushman, John Everett, and Carole Frank Nuckton
(1977) Further evidence on the relative performance
of proprietary and nonprofit hospitals. Medical Care
(March):189-204.
Larson, John G. (1983) Factors in the success of the
investor-owned hospitals: Implications for the not-for-
profits. Hospital and Health Services Adrrunistration
(March/Apnl):43 49.
Lewin, Lawrence S., Robert A. Derzon, and Rhea
Margulies (1981) Investor-owned and nonprofits differ
in economic performance. Hospitals 55:52-58.
Mullner, Ross, Calvin S. Byre, and Joseph D. Kubal
(1983) Hospital closure in the United States, 1976-1980:
A descriptive overview. Health Services Research
18~3):437~50.
Pattison, Robert V., and Hallie M. Katz (1983) Inves-
tor-owned and not-for-profit hospitals: A comparison
based on California data. New EnglandJournal of Med-
icine 309~6):347 353.
Relman, Arnold S. (1980) The new medical-indus-
trial complex. New England Journal of Medicine
303~17):963 970.
Sloan, Frank A., and Robert A. Vraciu (1983) Inves-
tor-owned and not-for-profit hospitals: Addressing some
issues. Health Affairs 2:25-37.
Tillet, J. William, R. Bruce Linklater, and Randy A.
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OCR for page 321
APPENDS A
VARIABLES INDEX SCORE
Service
1. Substance Abuse Unit
2. Medical/Surgical Intensive Care
3. Coronary Care
4. Combined Intensive Med/Surgical
Coronary Care
5. Neonatal Intensive Care
6. Burn Intensive Care
7. Emergency Services with 24-hour In-
House Physicians Only
8. Emergency Services with 24 hour
On-Call Physicians Only
9. Ambulatory Surgery Services
10. Ambulance Services
11. Labor and Delivery Services
12. Neurological Surgery
13. Open-Heart Surgery
APPENDIX B
Weight
2.2
4.7
4.7
5.0
4.4
5.0
3.4
2.3
2.7
2.3
3.0
4.2
5.0
Service
14. Recovery Services
15. Blood Bank
16. Cardiac Catheterization Laboratory
17. CT Scanner
18. X-Ray or Cobalt Therapy
19. Respiratory Therapy
20. Physical Therapy
Occupational Therapy
~, _ , ,
21.
22. speech-Language ethology
23. Renal Dialysis Inpatient or
Outpatient
24. Organ Bank
25. Social Work Services
26. Pharmacy Full-Time Registered
Pharmacist
27. Psychiatric Acute Care
SPECIALTIES INCLUDED IN PHYSICIAN MIX
SCORE
1. Allergy and Immunology
2. Anesthesiology
3. Cardiovascular Diseases
4. Colon and Rectal Surgery
5. Emergency Medicine
6. Endocrinology
7. Family/General Practice
8. Gynecology (Surgical)
9. General Surgery
10. Internal Medicine
11. Neurosurgery
12. Obstetrics and Gynecology
13. Oncology-Hematology
Weight
2.6
3.4
4.0
4.0
3.7
2.3
2.0
2.0
1.8
3.7
2.7
2.0
3.0
2.5
14. Ophthamology
15. Orthopedic Surgery
16. Otorhinolaryngology
17. Pathology
18. Pediatrics
19. Plastic Surgery
20. Psychology
21. Pulmonary Diseases
22. Radiology
23. Ihoracic/Cardiovascular Surgery
24. Urological Surgery
25. Other Clinical Specialties
327
Representative terms from entire chapter:
ownership change
