Hospital transfers ownership to employees

A facility finances an exit strategy for its owners by transferring corporate stock into an employee pension plan.

By Katherine Vogt — Posted Aug. 21, 2006

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It disappeared from the hospital arena for nearly 20 years. But now the old strategy of offering an employee stock option plan, or ESOP, is being revisited by a small hospital in Memphis, Tenn., in a move that may reflect changing times in the industry.

Delta Medical Center, a 170-bed general acute care hospital, announced in July that it had established an ESOP and placed all of its corporate stock into an employee pension plan, thereby transferring ownership of the facility from two private owners to the employees.

Neil McLean and Craig Watson had owned the for-profit hospital since 1999 but needed an exit strategy because they are "getting to be old men," said McLean. He said employees were displeased by discussions about selling the hospital to larger corporate entities so they tried to come up with an alternative solution.

"We thought that this would be a good solution to our issue of an exit strategy and one that the employees would reap the benefits [of]," said McLean, who remains chief executive officer of the hospital.

The move is unusual in an industry that has rapidly consolidated in recent years.

Michael Keeling, president of the ESOP Assn., a national trade association of ESOP companies, said "a couple handfuls" of full-service private hospitals had ESOPs in the mid-1980s, but the trend dropped off as the industry was transformed into a series of hospital chains.

"Now you're looking at a situation where I can't think of a full-service hospital that is a member of this association," he said.

Keeling said ESOPs likely became less attractive to for-profit hospitals as those facilities increasingly came under the ownership of larger entities that weren't as likely to reap the benefits of the plans.

The Delta transaction essentially worked like this: The hospital took out a bank loan and then lent that money to the ESOP. The hospital makes annual contributions from its operations to the ESOP, which then turns around and repays the hospital. In turn, the hospital uses that money to pay off the bank loan.

McLean declined to say how much money is at stake in this transaction. The hospital collects about $45 million in annual net revenue.

He said the biggest risk is whether operations are sustainable enough to make the annual contributions to the pension plan. He is wagering that they are, and that operations may in fact improve under the new ownership structure.

"We feel like the chances of operations improving are dramatic because of employee participation. The goals of the hospital and the employees are more closely aligned," he said.

If operations improve, it could make it easier for the hospital to secure future financing, he added. And in the meantime, Delta will enjoy a tax break because the contributions that it is making to the pension plan are tax-deductible.

The stock ownership is only available to employees who work at least 1,000 hours a year. No physicians fall into that category, but McLean believes the physicians who practice there will benefit in other ways.

"Improved operations obviously are going to generate more funds for capital equipment purchases, improvement of the physical plant and addition of services," he said.

Additionally, he hopes the new ownership might improve physician-hospital relations. "I think that medical staffs are often distrusting of corporate-owned facilities or hospitals. I believe they will work more closely with the management because of this structure," McLean said.

The failure of some ESOPs by high-profile companies, including United Airlines, might keep other hospitals from pursuing this strategy. However, other ESOPs have had success, earning employees millions of dollars and keeping the enterprises afloat for decades.

Richard Gundling, vice president of the Westchester, Ill.-based Healthcare Financial Management Assn., said interest may pique among hospital leaders as they continue to search for new financing strategies.

"As health care looks at its capital access needs, all the different types of financing options are being addressed," he said. "I've seen more and more providers look at the complete spectrum from bonds, stocks, leasing and funding from their own operations."

"It's probably not a bad idea to balance the different types of financing you have," Gundling added.

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