Acquisitions: Time to Sell?

In early 2004, things weren’t looking so hot for Scott Pargot’s Montana otolaryngology practice.

The Helena Ear, Nose, and Throat Clinic had just lost its office manager, and paying health premiums for the clinic’s eight employees had turned into a serious hardship. The clinic was also having no luck getting on the preferred provider list for the area’s dominant managed care plan - unless it accepted a painful discount.

Then Pargot noticed that some of his colleagues who had sold their practices to the nearby hospital and became employees of that hospital seemed a lot happier - stress-free, even. After doing his homework, Pargot and his partner decided to take the plunge, and they sold their practice to St. Peter’s Hospital in June of that year. They haven’t looked back since.

The hospital took over all of the practice’s business operations, freeing Pargot to spend his days doing what he wanted - practice medicine. And Helena Ear, Nose, and Throat Clinic quickly made it onto the provider list that had been so elusive.

“This has really worked out as a sound business decision for us, while building on our collegial relationship with the hospital,” Pargot says.

Halfway across the U.S., Kay Durst, MD, was facing oppressive malpractice insurance costs. Like Pargot, she looked to a hospital system to alleviate these and other headaches.

Pargot and Durst are on the forefront of a trend surfacing among physicians practices, or rather, re-surfacing - particularly in small- to medium-sized markets. Arranged marriages between physician practices and hospitals were common only a decade ago, when practices linked with their local hospitals, either through financial partnerships or outright sales and employment contracts.

In the late 1990s, though, many of those relationships soured and split. But, according to industry observers, the latest version of the integration trend is a whole different animal - better, healthier, and more manageable.

Why the first marriages failed

What went wrong with the first generation of these arrangements, and why won’t it happen again?

Well, a number of mistakes have been corrected, explains Bruce Johnson, a healthcare attorney with Faegre and Benson, LLP, in Denver, who has worked with hospitals and practices attempting to integrate in recent years. In the 1990s, hospitals essentially overpaid to lure independent physicians to be their employees, giving them salaries significantly higher than what they had been earning in private practice.

Productivity soon fell among many of these hospital-owned practices, and doctors who had been seeing 40 patients a day dropped to, say, 30, because patient load didn’t affect their salaries, says Johnson. The bottom line of these practices suffered, and so did the hospitals.

Hospitals also stripped many “cash-cow” ancillary services (i.e., X-ray, MRIs) from the practices they acquired, rerouting patients to the hospital for those services. As a result, those practices didn’t show the same profits they were bringing in before they were acquired; in many cases, they posted losses.

Hospitals, upset with the affect all of this was having on their balance sheets, subsequently attempted to cancel many of their multi-year contracts with physician practices.

“Back then, there were grandiose plans to create these huge provider networks to negotiate managed care contracts - some of which came to fruition, some of which didn’t,” says Johnson.

In today’s new wave of acquisitions, hospitals are typically paying for a clinic’s hard assets (i.e., its furniture) - and are being ultra-careful to closely tie physician compensation to production.

“To be successful, these models have to be built on shared expectations of performance,” Johnson explains.

Bob Gomes, vice president of physician services for St. Peter’s Hospital - the system to which Pargot sold his practice - agrees. Doctors who join the system are now paid a percentage of their gross submitted professional fees, and that percentage increases in a tiered fashion as productivity increases, he says.

Doctors who bill $220,000 per year net 24 percent of that, with percentages increasing along with billing charges. Payment tops out at 42.5 percent for physicians bringing in more than $450,000 in annual charges. And these percentages apply to all doctors in the system - from primary care docs to specialists, says Gomes.

For their part, physicians gain by getting greater stability through capital investment, debt relief, hiring and firing of staff, contract management, human resources services, technology management - all of which is taken over by the hospital’s administrative staff.

Arrangements can favor physicians

Johnson adds that physicians entering into these arrangements suddenly cease to be entrepreneurs, which automatically builds more flexibility into their personal schedules. This can be attractive to the older doctor hoping to slow down a bit, or the younger doctor wanting to spend more time with his family. Payments are specific to each individual, so if your partner leaves, there’s no worry that a chunk of your salary will, too.

The terms of these new contracts are different, too. Some are only for one year, with the option of renegotiation. As a result, neither party is stuck in a deal that doesn’t work for one or the other.

The impetus for these modern marriages has also changed, with physicians now being the ones usually pursuing them. In many markets, physicians see them as a solution to the same woes that Pargot once faced - diminishing payment and challenging market forces such as escalating premiums and tight provider lists, says Darrell Schryver, principal consultant with the Medical Group Management Association.

“The motivation is coming not from the hospital administrators so much, but physicians saying, ‘Something has to be done. I have to either look at the integrated model or move to a larger metro area,’” says Schryver.

Much of this acquisition activity is taking place in small and rural markets in which physicians are struggling with a declining patient base and other problems. These arrangements may be serving to keep some of them in their communities, where healthcare access is often limited.

When things go awry with their bottom line, small town docs typically close shop or relocate to a larger city, Schryver says. Partnering with a local hospital allows them to stay. Hospitals also benefit, he adds; having more doctors onboard can increase their negotiating power regarding managed care contracts, boost Medicare and other government payments, and generally attract more patients.

In larger and more flush markets, a more complicated strategy may be behind these recent acquisitions, says Brian White, managing partner of practice management for the consulting firm Competitive Solutions, LLC, of Nashville. In these locales, intense competition for new physicians - essentially attempts to pluck physicians away from competing hospitals - is propelling change.

“In sports parlance,” says White, “the physicians not employed by a hospital are free agents. The hospitals want to sign the free agents to play exclusively for their teams. If one hospital in a market begins to offer significant salaries or benefits to attract more physicians to its staff, the competing hospitals in the market may feel pressure to make similar offers.”

A win-win situation

Kay Durst’s bustling, three-doctor primary care practice, Durst Family Medicine PA in Ft. Lauderdale, was paying in excess of $30,000 per doctor in malpractice premiums in 2005 - double that of the previous year. Thinking about this year’s premiums was giving this physician hives.

Making matters worse, Durst says, were the escalating costs of providing health insurance and retirement benefits to the practice’s 10 employees. Lately, says Durst, she had been working harder and worrying more, with less to show for it at the end of the day.

“I want to spend my time seeing my patients - not wrestling with administrative issues,” she says.

Her answer? Sell.

Luckily, nearby Holy Cross Hospital wanted to buy. The 50-year-old hospital had acquired physician practices in the past, but then curtailed its acquisitions when many of the practices under its corporate umbrella began facing financial challenges common to the industry. During that time, Holy Cross says it took a different approach than most hospitals by not divesting its Medical Group, which it considered a core strategic initiative and partner.

Officials say Holy Cross is stronger today due to its physician affiliations, and that it is ready to have another go at acquiring practices.

As part of the agreement between Durst and Holy Cross, which at press time was inches from being signed, Durst will turn over most of her practice’s business operations to the hospital, which will buy her fixed assets as well as provide her a transition base salary and a production-based bonus for the first year. Ultimately, Durst will be compensated for her productivity.

In addition, Holy Cross provides malpractice insurance to its employed physicians. Durst says she expects her take-home salary to remain roughly the same or better than it was, but she says her stress level will likely plummet.

Robin Mautino, manager of physician relations for Holy Cross, says Durst’s practice is likely the first of several such acquisitions to come for the hospital. Holy Cross - one of three hospitals within a three-mile radius - hopes the acquisitions will help it “meet our medical staff development plan needs and fulfill our mission to serve the needs of the community” as well as stabilize the base of local physicians, says Mautino. South Florida has been losing physicians to other states due to escalating malpractice rates, she explains.

“It’s difficult recruiting doctors right now, but providing a stable employment opportunity, malpractice coverage, combined with the proven track record of a quality hospital, is attractive to many physicians,” Mautino says.

Durst is happy that signing on with Holy Cross will save her 25-year-old practice thousands in malpractice premiums and provide the financial security of being part of a larger healthcare entity. She also expects the practice to benefit from Holy Cross’s greater power to negotiate favorable rates with managed care companies. With the support of Holy Cross, she intends to stay active in charting future directions for the practice. “I am excited,” says Durst. “I’m ready.”

Structures limit risk, independence

Hospitals and physician practices are using three basic models to forge their partnerships, which vary based on the amount of financial risk and independence hospitals provide physicians. Physicians give up the most control in the “direct employment model,” in which a hospital buys the entire practice and the physicians become employees of the hospital. Sometimes hospital committees allow physicians some power in the governance of their practices. That is the sort of deal Pargot struck.

The “captive group model” is another option. In this situation, a hospital forms a physician group, which is a separate entity but still owned by the hospital. Physicians can retain some control of the group’s direction through participation in a board of directors and a committee structure. This arrangement feels most like private practice, says Johnson. However, a hospital can exercise veto power if its leaders oppose something the group’s board has endorsed.

Last is the “service-agreement model,” in which physicians stay truly independent but enter into a contract to provide services through the hospital. They may choose to sell a percentage of their practice to the hospital.

To one degree or another, these arrangements seek to maintain some level of physician input.

“Physicians and hospitals have both learned over the years that the best integrated models are where doctors can preserve a sense of ownership,” Johnson says. “When you remove their sense of ownership, it’s no good for anybody.”

In arrangements that give physicians a significant amount of involvement in the management and governing of the newly constituted healthcare system, says Schryver, “Physicians are not seeing a great deal of difference in going from a large private practice to a hospital system.”

But those physicians who like control over all operations and the future direction of their practice may want to pass these deals by. “Loss of autonomy is the biggest downside for physicians,” says Gomes. “That’s a transition. The staff no longer works for them. They have to let go and trust the administration to have their best interest at heart.”

Worth the trade-off?

Pargot had a hard time with that at first. He feared signing on with St. Peter’s meant he would be forced to shoulder the overhead of all the other physicians in the hospital’s physician group. To ensure that would not be the case, he made a limited deal with the hospital for the first six months. He then made a longer arrangement. “It was, I learned, set up so there were no undue burdens,” he says.

Pargot also worried that his time off might be unreasonably restricted, and that perhaps St. Peter’s would require long lead times before granting vacation time. Turns out that as long as productivity isn’t affected, the hospital has no problem giving their physicians ample vacation time. And doctors can take vacations with little notice.

Pargot liked the fact that the hospital made available to all its physicians the financial information regarding each practice it had acquired. But that also made him worry that his referrals might dry up when other primary-care physicians also employed by the hospital saw how high his salary was.

But when he realized that all physicians, regardless of specialty, are on the same production-based incentive program, Pargot relaxed.

Things did go awry once. Pargot learned that St. Peter’s central billing department wasn’t giving him credit for hearing tests he’d performed on Medicare patients. This alarmed him, he says, as his salary there is based on his charges. But all it took was an e-mail to the hospital’s vice president to remedy the problem.

Does it ever feel like Big Brother is watching? “There’s always that there,” says Pargot. “And my partner might say, ‘They did this,’ or ‘They did that,’ and I always say, ‘Yeah, but look how much better this is than it was.’”

And the system has shown its willingness to invest in its doctors. St. Peter’s is currently sending Pargot and several of his colleagues to business seminars to bone up on things like cost-basis accounting so they will become better equipped to lead the hospital into the future through committee appointments and other leadership positions. In June, Pargot will become St. Peter’s chief of staff.

These new arrangements may also result in better patient care. Gomes says he’s trying to streamline the system to make it more user-friendly for patients. And St. Peter’s is working to collect outcome data across its entire system to give patients more information on the care the hospital delivers.

“This doesn’t mean we’re in Utopia - but we’re trying,” says Gomes.

Suz Redfearn is a freelance writer and editor with more than 10 years of experience writing about business and healthcare issues. She can be reached via editor@physicianspractice.com.

This article originally appeared in the May 2006 issue of Physicians Practice.