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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

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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

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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

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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

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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

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312 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

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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

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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

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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

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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,

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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

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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. Sucher (1982) Survey reveals trends in corporate re- organizations. Hospital Financial Management (Sep- tember):38~. White, William D. (1979) Regulating competition in a nonprofit industry: The problem of for profit hospi- tals. Inquiry 16:50-61.

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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