Blog | Tuesday, October 6, 2015

Mergers and management--health care has been here before

We've been here before. Well, sort of. The gradual consolidation of physician practices into large multispecialty groups and integrated delivery systems is not a new concept. The U.S. health care industry underwent a similar transformation 20 years ago. The difference is that last time we were probably ill-equipped to handle things.

Let's start with a little history. Health insurance as we know it was blueprinted after J.F. Kimball's hospital insurance plan for teachers at Baylor University in 1929, a model that birthed the Blue Cross plans. And while health insurance grew in scope and complexity over the next 50+ years (notably with the national wage freeze during World War II and Medicaid and Medicare being signed into law in 1965), it was the 1980s and 1990s that saw legislation and changes that molded the health insurance industry into its current state.

Prior to the 1980s and 1990s fee-for-service medicine—the more one does in terms of volume, time, and complexity, the more one gets paid—essentially was unchecked. The result was a health care industry that emphasized volume with little regard or incentives for quality, efficiency, or service. This in essence led to overutilization of the system on the part of physicians, organizations, and consumers alike.

In an effort to rein in costs, the health insurance industry saw increased Medicare and Medicaid regulation and the maturity of managed care. Soon Health Maintenance Organizations (HMOs) and concepts such as diagnosis related group (DRG) payments and capitated payment models—where a fixed amount of money per patient per time unit is paid prospectively to physicians to cover patient care—started to replace the traditional fabric of fee-for-service medicine. As further complexity and uncertainty of payment reform loomed, physicians and hospitals alike found themselves looking to equip themselves with appropriate administrative expertise and economies of scale. Out of the need for physician practices and hospitals to manage the business of increased regulation, varying complex payer contracting, and the growing concept of population health management, physician practice management (PPM) companies were born.

Prevalent in the 1990s, PPM companies were management corporations that provided administrative support and financial management of physician practices in exchange for percentages of income or revenue. More specifically, practices and medical groups acquired by PPM companies received instantly increased economies of scale, which aided in improved contact negotiations and consolidated purchasing discounts; administrative manpower and expertise to manage the growing complexities of health care; streamlined operations; improved telecommunications; and access to capital for practice expansion. PPM companies also usually purchased the assets of physicians groups, from practice equipment to accounts receivable, and non-physician employees became employees of PPM companies. Physicians retained practice and clinical autonomy, continuing to have control over medical policies and physician personnel matters. In exchange, PPM companies collected somewhere around 20% of practice net incomes, and service contracts were set for 30 to 40 years.

PPM companies primarily grew through physician practice and medical group acquisitions. Other substantial sources of revenue included capitated contract earnings, improved practice margins, and same-clinic growth. By 1997, there were over 30 publicly traded PPM firms. The 2 undoubted leaders in this space were Birmingham-based MedPartners and Nashville-based Phycor. MedPartners was a multispecialty PPM company, had over 10,000 affiliated physicians, and yielded $2.5 billion in revenue and $134 million in net income in 1996. Also a multispecialty company, Phycor had over 12,000 affiliated physicians and earned revenues of $766 million with a net income of $36 million in 1996. This success was relatively short-lived however, and PPM companies were essentially non-existent by the early 2000s.

So … what happened???

One could argue that the lack of sustainability of PPM companies was the result of a concept that was too far ahead of its time. Rephrased, PPM companies lacked the technological capabilities and infrastructure to successfully function long-term. These firms by and large did not have the expertise of managing conglomerates of medical practices. In addition to being tasked with attempting to transform physicians (a long-time autonomous profession) from entrepreneurs to employees, PPM companies had difficulty getting physicians to maintain their levels of productivity once employed. The relationships between physicians and their PPM companies thus often times became strained.

The larger, multispecialty PPM companies also discovered that there were frequently incongruent strategic goals and priorities amongst different medical specialties. Furthermore, with increasing complexity and growth also grew higher corporate overhead costs. Many PPM companies subsequently found themselves in situations where it was difficult to make meaningful profit margins. Strapped for capital, PPM companies began to dissolve contracts and divest physician practices. Not surprisingly, Wall Street caught wind and began to abandon these companies that they had poured money into just several years prior. By the late 1990s, many PPM companies found themselves in financial peril. MedPartners announced it was leaving the PPM company industry in 1998, and Phycor filed for restructuring through chapter 11 bankruptcy in 2002.

Fast forward to 2015.

U.S. health care is again an environment with a myriad of reforms, guidelines, and regulations. While health care is still predominantly provided in a fee-for-service manner, both commercial and government insurance programs are placing an increasing emphasis on value over volume. That said, physician practices are finding themselves in a place where assessing patient characteristics and health outcomes has become paramount for revenue.

Possessing a comprehensive, well-functioning electronic medical record has grown from being an asset to a necessity and is now one of the largest operational costs a medical practice can have. Additionally, having administrative support that can not only manage technology, but that can also efficiently manage billing, coding, and contracting, has become a must. Physician practices, especially in primary care, have thus found themselves in a place where larger economies of scale are necessary to function appropriately and to yield a profit of any kind. The American Medical Association reports that only 17.1% of physicians are in solo practices, down from approximately 23% in 2007/2008. Also, in 2014 50.8% of physicians were practice owners, and 25.6% were in practices with at least some hospital ownership. In 2007/2008, these numbers were over 61% and only 16.3%, respectively.

Physician practices and hospitals alike continue to merge and form alliances as we trudge through this period of uncertainty in U.S. health care. Even for practices that remain solely physician-owned small businesses, it is not uncommon for purchasing and insurance contracting to be done in conjunction with other physician practices in the form of independent physician associations (IPAs). Individual hospitals are becoming parts of hospital systems, and it is becoming rare for non-concierge primary care practices to not have some sort of affiliation with a health care system. Large health care integrated delivery systems are now frequently amongst the largest (if not the largest) employers in major metropolitan areas throughout the country.

This trend does not seem to be slowing down any time soon as healthcare reimbursement reform steams ahead. In comparison to 20 years ago hospital systems and large multispecialty medical groups now have the expertise, technology, and leverage to acquire, manage, and grow medical practices. However, we should remain cautious and careful in this period of mass acquisitions and mergers, as one should not ignore that we have essentially been here before.

Kenneth G. Poole Jr., MD, MBA, FACP, practices medicine in Scottsdale, Ariz.