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For-Profit Enterprise in Health Care (1986)

Chapter: 3 Trends in the Growth of the Major Investor-Owned Hospital Companies

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Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
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Page 250
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
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Page 251
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
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Page 252
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
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Page 253
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
×
Page 254
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
×
Page 255
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
×
Page 256
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
×
Page 257
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
×
Page 258
Suggested Citation:"3 Trends in the Growth of the Major Investor-Owned Hospital Companies." Institute of Medicine. 1986. For-Profit Enterprise in Health Care. Washington, DC: The National Academies Press. doi: 10.17226/653.
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For-Profit Enterprise in Health Care. 1986. National Academy Press, Washington, D.C. Trends In the Grown of the Major Investor-Owned Hospital Companies Elizabeth W. Hoy and Bradford H. Gray Some of the most basic facts about the growth of the investor-owned hospital companies have never been documented, although they have often been topics of conjecture and specula- tion. To what extent have these companies grown through the construction versus the ac- quisition of facilities? Does the previous own- ership of acquired hospitals suggest that the investor-owned sector is replacing the public or not-for-profit sectors? To what extent have these companies closed hospitals? How similar are the major companies in such growth pat- terns? To provide at least a partial answer to such questions, we have examined the growth of six of the largest investor-owned hospital chains, which owned 58 percent of the 890 such hos- pitals as of September 30, 1984 (as shown in the 1985 directory of the Federation of Amer- ican Hospitals [FAH]~. These companies are the Hospital Corporation of America (HCA) which owns 200 hospitals; American Medical International (AMI) with 115 hospitals; Hu- mana, Inc., with 87 hospitals; National Med- ical Enterprises (NME) with 47 hospitals; Charter Medical Corporation (Charter) with 41 hospitals; and Republic Health Care Cor- poration (Republic), with 24 hospitals. A1- though several of these companies own psychiatric hospitals, the analysis presented in this paper is confined to 540 domestic hospitals that the American Hospital Association (AMA) classifies as "short-term, general, and other special hospitals." Included are all such hos- pitals that were constructed, bought, leased, sold, merged, or closed between the inception of each company and the time of their 1984 filings with the Securities and Exchange Com- mission (SEC).~ Our primary sources of information about these hospitals were the companies' annual re- ports and filings with the SEC, especially their 250 10-K reports.2 These reports, which must be filed annually by all publicly traded compa- nies, are comprehensive statements that de- scribe principal products and markets, the location and character of principal properties, a summary of the events of the previous fiscal year, and financial statements. Other sources of information were the AHA annual Guide to the Health Care Field and the FAH annual Directory of Investor-Owned Hospitals. The few questions about hospitals' histories that could not be answered from these published sources were taken to the companies them- seIves, which provided answers and in several cases checked our other data. SOURCES OF GROWTH As Table 1 shows, acquisitions through pur- chases (68 percent of growth) and leases (12 percent of growth) have far outdistanced con- struction (20 percent) as a source of the growth of the six companies. Companies varied widely in sources of growth with HCA, Humana, and Charter having originally constructed more than 25 percent of their hospitals, while none of Republic's and only 4 percent of AMI's hos- pitals were built by those companies. These differences are undoubtedly partly a matter of strategy, although Republic's relative youth may also be a factor. Most of the companies studied did not construct hospitals in their first few years of operation. The data on new hospital construction do not fully measure the construction activities of these companies. Table 2 shows three types of such activities -- new construction, replace- ment of existing facilities, and addition of beds to existing facilities. Part of the increase in these six companies' bed capacity came from capital improvements to facilities they had previously constructed or

GROWTH OF INVESTOR-OWNED COMPANIES 251 TABLE 1 Sources of Growth of Short-Term General and Other Special Hospitals by Six Selected Corporations, All Hospitals Acquired Through 1984 Activity All Six HCAa HumanaAMI NME Republic Charter Total hospitals acquired 540 202 124114 50 31 19 Constructed (%) 20 27 264 12 0 26 Purchased (%) 68 62 5688 80 76 58 Leased (%) 12 11 188 8 24 16 aHCA data are through 1983. acquired. Renovations and expansions oc- curred in 23 percent of facilities owned by these companies. The beds added through These activities account for 7 percent of the total number of beds owned by the six companies. The six companies completely replaced 11 per- cent of their facilities with newly constructed buildings. Beds added in the process account for 2 percent of current bed capacity (7,983 beds). The magnitude of expansion/replacement activities varied widely among the six com- panies. At the high end, 11 percent of the bed capacity of the HCA derives from capital ex- penditures at facilities already owned; 50 per- cent of their hospitals were affected. At the other end, 3 percent of AMI's beds derive from capital expenditures at facilities they owned and 21 percent of hospitals were affected. Re- public Health Corporation did not expand or replace any hospitals during the period ex- amined. (See Table 1.) Growth Trends Over Tane Table 3 displays growth trends data for the six companies. Clearly, construction ac- counted for a much larger share of these com- panies' growth during the 1970s than either before or after. However, the percentage de- cline in share of growth via construction (from 27 percent between 1975 and 1979 to 11 per- cent between 1980 and 1984) resulted pri- marily from a surge in acquisition activity, not to a substantial slowing of construction. Through 1969, only 49 hospitals were owned by these six companies. Beginning around 1970, the three companies that are the largest today began a period of rapid expansion. Between 1970 and 1972, HCA added 27 hospitals, 13 of which were constructed. Humana added 36 hospitals, 4 of which were constructed. AMI added 31 hospitals; one of these was con- structed and 21 were acquired in a merger with Chanco in 1972, more than doubling the size of the company. Charter and NME ex- hibited much slower growth in short-term general hospitals during this period. This probably reflects the greater diversification of these two companies while they were entering the general hospital market. During the mid-1970s, HCA and Humana both began constructing more of their new hospitals. Twenty-seven of the 50 hospitals added to HCA between 1973 and 1979 were constructed by the company. All but two of the 23 hospitals added by Humana between 1973 and 1977 were constructed. AMI did not grow during this period, having previously made the acquisition of the Chanco hospitals that had more than doubled the company. In the late 1970s and early 1980s, growth through the acquisition of over investor-owned chains by the larger ones became particularly notable. HCA acquired three smaller chains (i.e., General Care Corporation, General Health Services, Inc., and Hospital Affiliates International, Inc. tHAI]) in 1980 and 1981. These 48 hospitals represented 60 percent of their growth in those 2 years. Humana ac- quired 39 hospitals through its merger with American Medicorp in 1978, almost doubling their capacity. AMI continued its strategy of growth primarily through the acquisition of chains, by acquiring Hyatt (eight hospitals) and BrooLwood Health Services (11 hospitals) in 1981 and 1982, respectively, and in 1984, AMI acquired Lifemark's 27 hospitals through a cor- porate merger.

GROWTH OF INVESTOR-OWNED COMPANIES TABLE 3 Growth in Four Time Periods of Short-Term General and Other Special Hospitals by Six Investor-Owned Corporationsa Total All Before Activity Years 1969 1970- 1974 1975- 1979 1980 l984b Total hospitals acquired 540 49 131 111 249 Constructed (%) 20 4 35 27 11 Purchased (%) 68 90 58 56 75 Leased (%) 12 6 7 17 14 aHCA, Humana, AMI, NME, Republic, and Charter. bHCA data are through 1983. Republic was founded in 1981 by four for- mer executives of HAI and has grown to the fifth largest investor owner of general hospitals by purchasing two-thirds of its hospitals from other investor-owned chains. They purchased 16 hospitals from HCA in 1983, 8 of which were former HAI hospitals. Then in 1984, they acquired Health Resources (three hospitals), two hospitals from Humana, and one general hospital (along with several psychiatric or sub- stance abuse hospitals) with their acquisition of Horizon Health-the owner of Raleigh Hills substance abuse hospitals. lYPES OF HOSPITALS ACQUIRED Previous Ownership Table 4 shows that these six companies have grown prunarily Trough the acquisition of other hospital chains (45 percent of all hospitals ac- quired) and independent proprietary hospitals (33 percent of all hospitals acquired). (This fig- ure has been adjusted to compensate for the 22 hospitals that changed hands in transactions among the six companies.) Twelve percent of the acquired hospitals were previously under private not-for-profit ownership (mostly vol- untary rather than religious), and 10 percent were previously owned by state and local gov- ernments. Previous ownership also shows definite trends when examined over time (Table 51. Initially, most hospitals acquired were small indepen 253 dent proprietary hospitals. Not-for-profit and governmental hospitals did not assume a sig- nificant portion of acquisitions until the most recent period examined" 1980-1984. It is often difficult to determine the original ownership of hospitals that were acquired by these six companies from other proprietary chains. The most complete data we have come from the set of hospitals acquired by HCA through General Care Corporation, General Health Services, Inc., and HAI. These hos- pitals were almost exclusively either indepen- dent proprietary hospitals before they were acquired by any chain or they were con- structed by a chain. This pattern appears to hold for the other companies studied, although we were unable to assemble complete data. Once acquired by a hospital chain, a hospital can go through a series of changes of ownership as a result of the merger and acquisition ac- tivity among hospital chains. Perhaps the most vivid example are two California hospitals, Community Hospital of Sacramento and Lau- rel Grove Hospital, that went through the fol- lowing changes. Both were physician-owned proprietary hospitals until their acquisition by Beverly Enterprises in the early 1970s. They were sold by Beverly to AID, Inc., a subsidiary of the Insurance Company of Norm America (INA) in the mid-1970s. After INA acquired HAI, the AID hospitals were moved into the HAI division, which was sold to HCA in 1981. In 1983 the two hospitals were among eight that HCA sold to Republic, their present owner.

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GROWTH OF INVESTOR-OWNED COMPANIES TABLE 5 Trends in Previous Ownership of Short-Term General and Other Special Hospitals Acquired by Six Investor-Owned Companiesa Ownership at Before 1970- 1975- 1980 Acquisition Total 1969 1974 1979 1984b Investor-owned chain 194 0 Investor-owned independent Voluntary not-for profit 146 45 24 48 51 16 119 37 41 1 7 5 28 Religious not-for profit 12 0 2 3 7 State and local government 43 1 5 7 30 Total 436 47 86 82 221 . aHCA, Humana, AMI, NME, Republic, and Charter. bHCA data are through 1983. Size of New Hospitals Data on the size of hospitals constructed, purchased, and leased are displayed in Table 6. For the six companies, the average size of the hospitals constructed (153 beds) was slightly larger than the size of hospitals purchased (though not smaller than leased hospitals). For all three modes of acquisition, the size peaked in the period 1975-1979. Geographic Patterns In 1969, the six investor-owned chains owned hospitals in only 10 states with 75 percent of them concentrated in California, Texas, Ala- bama, and Tennessee. By 1984, they owned hospitals in 35 states, with 74 percent of their hospitals in seven states (the four listed and 255 Florida, Louisiana, and Georgia). Clearly the areas of greatest grown and concentration have remained in He South and Southwest. Since 1969, there has been a gradual spread into the Midwest and the Rocky Mountain area, but the six chains acquired no hospitals in several New England and Mid-Atlantic states. The Relationship Between Contract Management and Acquisition HCA was the only company that provided enough information in their 10-K reports to track the relationship between management contracts and subsequent purchase of hospi- tals. Since becoming a public corporation through 1983, HCA managed a total of 220 hospitals in 39 states. Of these, 33 contracts were terminated, presumably at the end of the TABLE 6 Average Number of Beds per Acquired Hospitals, Six Investor-Owned Companies,a Through 1984 l Before Hospital Type Total 1969 1970- 1974 1975- 1980 1979 1984b All acquired hospitals 142 128 118 171 144 Constructed hospitals 153 44 152 180 131 Purchased hospitals 136 134 102 153 145 Leased hospitals 156 84 77 212 152 aHCA, Humana, AMI, NME, Republic, and Charter. bHCA data are through 1983.

256 contract life. Seventeen managed hospitals were acquired by HCA during the course of the contract, and one was acquired after the con- tract had terminated. These represent 8 per- cent of HCA's total acquisitions. Seven of the 18 hospitals acquired were replaced by com- pany-built hospitals during the term of the contract and were recorded as constructed hospitals in our data. At the end of our data collection period, HCA managed 169 hospitals in 38 states. Contract management is clearly a separate line of business rather than a vehicle for acquisition. DIVESTITURES An oft-stated concern about the for-profit ownership of hospitals by for-profit entities is that such owners might be too willing to close a hospital that was not satisfying profitability goals. Although some studies (Sloan et al., 1986; Mullner et al., 1982) have shown that for-profit hospitals are disproportionately represented among hospitals that close, little data on clo- sure activity of investor-owne~ for-profit hos- pitals have heretofore been available. For this reason, we also compiled data on divestitures by the six largest investor-owned hospital com- panies. For the SLY companies combined, there were a total of 87 divestitures during the period studied-75 sales and 12 closures (Table 7~. This is a total of 16 percent of all hospitals acquired during this period. The percentage of hospitals divested varies by company, with Humana having the highest percentage of total divestitures (31 percent of the hospitals they FOR-PROFIT ENTERTRISE IN HEALTH CARE bought or constructed) and NME having a low 6 percent. Republic has not divested any hos- pitals, but this may be a factor of the relatively young age of the company. For the first years ofthese companies' existence, there were very few divestitures (Table 8~. Only 2 percent of all the hospitals acquired by the six companies during the period studied were subsequently closed. In several of these cases, the closure was associated with, and compensated by, the addition of new beds at another area hospital owned by the same com- pany; one was converted to a psychiatric hos- pital. None of the hospitals that were closed appeared to be the only hospital in a com- munity. AMI exhibited the highest absolute number of closures (six). NME and Republic did not close a hospital. Table 9 shows the number of years between the time of acquisition and the time of dives- titure for the 87 hospitals that were closed or sold by these three companies through 1984. Divestitures appear to fall into several pat- tems. Sometimes computes acquire chains and Men divest themselves relatively quickly of hospitals that do not fit well with the company. Of the hospitals divested Trough sale or clo- sure, 45 percent took place within 3 years of the year of acquisition. Another cluster of hos- pital divestitures appears around 5 to 6 years after acquisition. One can speculate that these were hospitals that did not meet the acquiring companies' expectations regarding profitabil- ity. A third group of hospitals have been di- vested after 10 years or more of ownership. One can speculate that these are hospitals that have outlived their investment potential (i.e., TA;BLE 7 Divestitures of Short-Term General and Other Special Hospitals by Six Companies, Through 1984 Activity Total HCAa Humana AMI NME Republic Charter Total hospitals divested 87 26 39 14 3 0 5 Number sold 75 23 38 8 3 0 3 Number closed 10 3 1 6 0 0 2 Percent divested as percentage of total hospitals acquiredb 16 13 31 12 6 0 26 aHCA data are through 1983. bAs shown in Table 1.

GROWTH OF INVESTOR-OWNED COMPANIES TABLE 8 Divestitures ~ a Percentage of All Hospitals Acquired by the Six Companies,a in Four Time Periods Before 1970 Ac~ivity Total 1969 1974 1975- 1980 1979 l984b Total hospitals divested 87 04 27 56 Total hospitals acquired 540 49131 111 249 Divestitures as percentage of acquisitions 16 04 24 22 aHCA, Humana, AMI, NME, Republic, and Charter. bHCA data are through 1983. Haney are reaching the end of their depreciable life) and that their cash-flow value to the com- pany may have declined. CONCLUSIONS Several major findings from this compilation of information about the acquisition and di- vestiture activities of the six largest investor- owned hospital companies through 1984 are worthy of note and commentary: · Most growth has been through acquisi- tion of existing facilities; only 20 percent (104 hospitals) of all hospitals owned or leased by the companies during this period were origi- nally constructed by the companies. · Approximately 13 percent ofthe hospitals purchased or leased by the companies were subsequently replaced. Replacement and ren- ovation activities added almost as many beds to the system as did the construction of new facilities. 257 ~ Almost half ot the hospitals acquired by these six companies were acquired in 1980 or later, with acquisitions of and mergers with other companies playing an important role. However, projections of future growth based on trends shown in this paper would be un- warranted in light of changing economic cir- cumstances brought about by Medicare and private third-party payers. · As has been widely assumed, most hos- pitals acquired were previously under for-profit ownership. However, 22 percent of purchased hospitals were acquired from a not-for-profit or governmental owner. Such sources in- creased in prominence during the last period studied (1980-19841. However, as noted above, growth trends of the late 1970s and early 1980s may not continue. ~ The size of hospitals purchased (and leased) and constructed peaked in the penod 1975- 1979 before declining in the 1980-1984 period. ~ Although significant geographic dispersal took place during the period studied, a high TABLE 9 Length of Time Between Acquisition and Div~ctitl~r~ far R7 Hn~nitolc C^1A ^' Closed by SLK Investor-Owned Hospital Companies,a 1970-1984 ~Kiev-~- TV vet Length of Time Total HCAb Humana AMI NME Republic Charter - 1-3 yearsC 39 21 10 5 1 0 2 4-8 years 33 3 22 4 1 0 3 9 or more years 15 2 7 5 1 0 0 UTICA, Humana, AMI, NME, Republic, and Charter. bHCA data are through 1983. CBased on year of acquisition and sale, not on exact dates.

258 degree of geographic concentration still char- acterizes these six companies, win almost 75 percent of Weir hospitals being located in seven states. · Acquisition by an investor-owned com- pany can lead to subsequent changes in own- ership. Sixteen percent of the hospitals built or purchased by these six companies had un- dergone a subsequent change in ownership. At the extreme, two examples were presented of hospitals Mat had changed hands five times after their initial purchase from local physician owners. · Closure of a hospital after acquisition by one of these companies has been rare. Only 12 of the 540 hospitals owned by these com- panies during the period were closed, and sev- eral of these closures were the result of the replacement of two old facilities by one new one. · There are substantial variations ire the growth and divestiture patterns of different companies. Whether this is `due to broad strat- egies or to ideosyncratic circumstances and events has not been determined. NOTES Can exception was the HCA for which the most re- cent data used was from its 1983 filings with the SEC. Hospitals that these companies operated under man- agement contracts were not included in the figures on acquisitions and divestitures. Beginning with the first year that each company filed with the SEC and owned one or more hospitals, the following information was compiled (and usually obtained) about each hospital owned by each company: · The name and location of the hospital · Year acquired · How acquired (i.e., constructed, purchased, or leased) · Type of previous ownership · Whether the hospital was previously managed by the company (if available) · Initial licensed bed capacity upon acquisition · Any additions to bed capacity and the year they occurred · If the hospital was replaced, when, and the num- ber of beds in the replacement facility · Current licensed bed capacity (1984 data) · Any additions to ancillary capacity, and the year they occurred · If the hospital was divested, how and when FOR-PROFIT ENTERPRISE IN HEALTH CARE Growth derives from construction, purchase, and lease. Constructed hospitals were recorded in the year they began operating rather than the year construction began. Hospitals constructed for other owners and then leased by the corporation under a capitalized lease ar- rangement were counted as constructed hospitals. Hos- pitals acquired after construction had begun and completed while owned by the corporation were counted as constructed rather than acquired hospitals. Hospitals that were constructed by others under agreements with the corporation and then acquired upon completion were categorized as either purchased or leased. The 10-K reports must list properties that are leased, but need not differentiate between capitalized and non- capitalized leases. Both capitalized and noncapitalized leases are included in our data under the category "leased." However, the majority of leases by investor- owned chains are capitalized leases; for example, 18 of the ~ leases recorded by Humana are capitalized leases. A capitalized lease, also known as a financing lease, is a leasing agreement that is followed by the option to purchase at a nominal price and is treated on the fi- nancial statements as both the borrowing of funds and the acquisition of an asset by the lessee (in this case, the investor-owned chain). Both the liability and the asset are recognized on the balance sheet. Expenses consist of both the interest on the debt and the am- ortization of the asset. The lessor treats the lease as the sale of the asset in return for a series of future cash receipts. An operating lease, or noncapitalized lease, grants the lessee no rights to the asset and the rental payments are accounted for as expenses of the period, not a liability. The lessor retains rights to the property and shows the rental payments as revenues. Purchased hospitals include those acquired through poolings of interest. When an investor-owned chain acquires a hospital (or hospital chain) through a pooling of interest, it exchanges previously unissued capital stock for the stock of the hospital and accepts respon- sibility to discharge tile liabilities of the acquired firm. In accounting terminology, a pooling of interest com- bines the two firms by adding together the book value of the assets and equities of the two firms. When a hospital is purchased, the transaction is accounted for by adding the acquired company's assets, valued at the price paid for them, to the acquiring company's assets. Because the assets are put on the books at current, rather than original cost, the depreciation expense (and its associated cash flow) is higher and the reported net income is generally lower under this method than un- der the pooling-of-interest method. Acquisitions are required to be accounted for as purchases unless all of the criteria for a pooling are met. For our purposes, poolings and purchases are both included in the terminology "purchased." Since the difference between a capitalized lease and a purchase is only one of the timing of the expenditure, leases and

GROWTH OF INVESTOR-OWNED COMPANIES purchases have been combined under the term "ac- quisition" in some tables. REFERENCES Mullner, Ross M., Calvin S. Byre, Paul Levy, and Joseph D. Kubal (1982) Closure among U.S. commu- nity hospitals, 1976-1980. A descriptive and a predic 259 tive model. Medical Care 20July) 699-709. Sloan, Frank A., Joseph Valvona, and Ross Mullner (1986) Identifying the issues: A statistical profile. In Frank A. Sloan, James F. Blumstein, and James M. Pernn, eds., Uncompensated Hospital Care: Rights and Responsibilities. Baltimore, Md.: The Johns Hopkins University Press.

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"[This book is] the most authoritative assessment of the advantages and disadvantages of recent trends toward the commercialization of health care," says Robert Pear of The New York Times. This major study by the Institute of Medicine examines virtually all aspects of for-profit health care in the United States, including the quality and availability of health care, the cost of medical care, access to financial capital, implications for education and research, and the fiduciary role of the physician. In addition to the report, the book contains 15 papers by experts in the field of for-profit health care covering a broad range of topics—from trends in the growth of major investor-owned hospital companies to the ethical issues in for-profit health care. "The report makes a lasting contribution to the health policy literature." —Journal of Health Politics, Policy and Law.

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