Acute interest: When doctor groups become owners

Physicians have emerged suddenly as bidders to buy hospitals. But are they making a wise investment?

By Katherine Vogt — Posted June 21, 2004

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Dozens of general acute care hospitals have been put up for sale in the last year, and physicians are responding like shoppers pursuing a blue-light special.

In an emerging trend that bucks tradition, physician groups appear to be increasingly attempting to buy these hospitals, some of which could be a bargain after losing money for their corporate masters.

While many physicians have invested in specialty hospitals, ambulatory surgery centers and diagnostic imaging centers, there have been few instances of physicians purchasing traditional hospitals.

But observers say that could be changing.

Several factors are aligning to fuel a trend. First, hospital ownership holds the seductive promise of helping doctors gain more control over their work environment and the quality of the care they provide. Also, it could provide doctors with a new source of revenue to offset declining reimbursements.

And with the future of specialty hospitals clouded because of an 18-month federal moratorium on their development, traditional hospitals have become more attractive.

But the challenges faced by these would-be physician investors are significant and might prevent some from completing deals. In addition to raising hefty sums of capital, they must structure their ownership carefully to avoid running afoul of regulatory laws. They must consider the ethical implications of their ownership. And some could suffer from a lack of experience in running a hospital, especially one that has historically operated on a narrow profit margin.

Still, the potential obstacles have not stopped several groups from bidding on hospitals put up for sale by Tenet Healthcare, which announced in January that it was divesting 27 hospitals, mostly in California. Physicians have also pursued hospitals from Texas to Illinois and Pennsylvania.

Making bids

Potential physician investors contacted by AMNews did not want to talk about their bids while negotiations are ongoing.

Although Tenet would not disclose which groups were bidding on its hospitals, Los Angeles-based health care consultant Steve Valentine said he thought at least eight of the hospitals were being sought by physician-led investor groups. And Jack Lewin, MD, chief executive of the California Medical Assn., said he knew that "a number" of physician groups had made bids.

"There are many physicians in California that believe aligning the interest of the physician and the hospital would better serve the patient than the current conditions," said Dr. Lewin, who added that he thought patient care could improve under a large group of physician owners.

He said physicians might be going after ownership stakes because of a sense among them that hospitals seem to be necessary partners rather than truly aligned constituencies.

"Even though physicians and hospitals are partners in health care, we are in fact competing for limited Medicare dollars, Medicaid dollars and insurance dollars. Quite frankly, physicians aren't doing very well in these competitions," he said. "Hospitals and physicians need to cooperate on many fronts much more effectively than we do."

Dr. Lewin said a medical group from Palo Alto was proceeding with plans to build its own hospital because its physicians think they can be competitive and more effective than other owners. He said other medical groups in California are thinking similarly.

Valentine said he had seen two types of physician groups express interest in purchasing hospitals. One is the HMO-dominated medical group seeking the ability to direct patients to a hospital. The other is a group of physicians on staff of the hospitals they are trying to buy.

"But just because a doctor owns a hospital doesn't mean it works any better or does not work better. You still have to have the fundamentals of a hospital, which is good demographics. The better the payer mix, the better a hospital will do," Valentine said.

Rick Kunnes, MD, head of clinical and operations consulting for the Irving, Texas-based health care cooperative VHA Inc., said physician owners might be able to increase a hospital's efficiency with patients because they know that side of operations.

"If you talk to physicians about what annoys them or upsets them most about hospitals, nine times out of 10 it's issues around throughput and convenience," he said. "So when they buy these hospitals, they have a very intense focus" on those issues.

Shifting trends

In recent decades, most acute care hospitals have been owned by large hospital chains, health systems or charitable organizations. Health care attorney Eugene E. Elder said that historically it has been uncommon for physicians to try to purchase general community hospitals.

Some potential physician investors might have been scared off from buying hospitals because of regulatory and legal concerns, said Elder, a partner with Akin, Gump, Strauss, Hauer & Feld in Washington, D.C.

"The regulatory climate for hospitals is one of a whole host of headaches," he said. "[The physician owner goes] from having to manage an active practice to really a much larger enterprise with a broader range of licensing issues, employment issues."

Perhaps the chief legal concern for potential physician suitors is qualifying for an exception to the federal Stark law, which prohibits physicians from making referrals to entities with which they have a financial relationship.

Elder said the so-called whole hospital exemption allows physicians to own a hospital, provided they have privileges there and they own part of the whole entity, not just some department. That way physician investors can't pursue only profitable sectors, such as labs.

Jaye Martin, a health care attorney in Minneapolis with Gray, Plant & Mooty, said physician investors need to be aware of other laws as well, particularly the federal anti-kickback statute, which criminalizes the payment of any remuneration in exchange for the referral of patients in federal payer programs.

Martin said there are ways to structure ownership interests to help avoid legal problems. He recommends making sure that the return on the investment is the same as what other investors have; ensuring that the return is in proportion to what was invested; and allowing the physician to have privileges at other hospitals.

Hard challenges

Elder said that even after physicians meet the legal requirements for buying a stake in a hospital, they should be careful because they might have side business relationships with other health providers that could raise legal questions.

Physician investors also face tremendous financial challenges in getting capital together to buy an acute care hospital, which can cost tens of millions of dollars. Ed Green, a health care attorney in the Chicago office of Foley & Lardner, said physicians sometimes can be their own enemies in efforts to raise money. "Doctors seem to be very risk-averse to investing. I think part of the problem is they actually know too much about the business they are in. When you know too much, you know about the downside."

Green said physicians probably would need to put down about 10% to buy a hospital. But Valentine said getting that financing is where doctors struggle. Not only do they have to come up with money for the purchase, but they also need working capital. "A lot of doctors are working a lot of hours, and getting this done can be difficult."

Valentine said lenders might be reluctant to loan money to physician groups, possibly requiring that the physician investors secure the loan with their personal assets. "By and large they're reluctant because doctors don't have a track record of running hospitals," he said.

And that lack of experience could present other business challenges to the physician investors, such as managing a large budget and keeping profit margins from disappearing.

Though some physician investors partner with companies experienced in running hospitals to handle management responsibilities, they still run the risk of having a losing venture simply because of the low profitability of some hospitals. And many hospitals put up for sale are those that lost money for their owners.

"I think there are very good reasons to be fearful for these physician groups," Dr. Kunnes said. "I think just as Tenet was having problems with these hospitals, these physician groups are going to come into a scenario where a high-performing hospital firm has, in effect, thrown in the towel."

Fearing the competition, hospital systems can make it difficult for physicians to get into the business. Green said some of them are trying to change the Stark exception and tweak state certificate-of-need laws to prevent physician ownership of hospitals.

Some question the ethics of physicians owning hospitals because of the potential for them to abuse their referral authority to increase revenue. For that reason, Dr. Kunnes said scenarios in which physician investors pursue nonprofit hospitals raise fewer ethical questions than if they go after for-profit hospitals.

Dr. Lewin said he would prefer to see physician owners in a nonprofit model. "What we want to see is that patients absolutely come first in any model and that profits are not the primary incentive," he said.

Cardiologist Nancy J. Pickering, MD, and her colleagues formed a group to take over MCP Hospital, a Tenet hospital in Philadelphia that was scheduled to be closed at the end of June. The group proposed running the hospital as a nonprofit entity, using a hospital management team to run the business while having physicians "at the helm of the ship."

The physicians donated money to a charitable foundation that would own the hospital if their proposal is approved, but have not invested with an expectation of financial return. They believe that contributing their insider knowledge of patient care could be a boon.

"We best know the health care needs of the community," Dr. Pickering said. "A lot of these doctors have been there 10, 20, 30 years. They know the people, and they have support."

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The future of the exemption

Physicians could be prohibited from buying hospitals if the federal government does away with a provision to the Stark law, which has recently come under scrutiny.

At issue is one of the exceptions to the law, which prohibits physicians from making referrals to entities in which they have a financial interest. The exception allows physicians to buy hospitals as long as the physician has privileges at the facility and owns a stake in the entire hospital -- not just a part of it. Physicians seeking acute care hospitals and specialty hospitals have used this whole-hospital exemption to clear the way for their purchases.

But the exemption recently came under scrutiny when the government decided to examine physician ownership of specialty hospitals.

Last fall, lawmakers ordered an 18-month moratorium on new specialty hospitals. And now some observers have questioned whether the government might put an end to all hospital ownership by doctors.

"If I were a physician investor, I would be fearful that the exemption won't be there forever," said Rick Kunnes, MD, head of clinical and operations consulting for the Texas-based health care cooperative VHA Inc.

He said lawmakers probably support the provision by a small majority now, but that could change.

Jaye Martin, a health care attorney in Minneapolis with Gray, Plant & Mooty, expects a tweaking of the law. "I think it is unlikely they will do away with whole-hospital exception in its entirety, but I think there's a very good chance there will be a permanent, significant narrowing," he said.

Martin said regulators could be more concerned with honing in on specialty hospital ownership rather than all hospital ownership by physicians.

"This moratorium could have been on hospital ownership, period, but it wasn't. This was on specialty hospital ownership in particular," he said.

But even if physician ownership of specialty hospitals is halted permanently while allowing physicians to own other hospitals, he doesn't expect to see a buying frenzy of general hospitals.

"I'm not so sure, even though the door is still open, that there will be some big boom," Martin said. "It's very possible that's why the regulators were willing to keep that door open."

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