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Catholic Health Initiatives and Dignity Health complete merger

Catholic Health Initiatives and Dignity Health sealed the deal Friday on their prolonged three-year courtship, according to the new system’s website.

The Chicago-based not-for-profit system—now known as CommonSpirit Health—has 142 hospitals, 150,000 employees, nearly $30 billion in revenue and more than 700 care sites across 21 states, including 30 hospitals in California. Among not-for-profits, it rivals Ascension in total hospitals, trailing by just nine facilities. CommonSpirit will be second to Kaiser Permanente in revenue. The California-based integrated delivery system racked up operating revenue of $72.7 billion in 2017, according to Modern Healthcare’s health system financials database.

“We created CommonSpirit Health because in order to solve national health challenges, we need the breadth, scope and resources to make a nationwide impact,” Lloyd Dean, Dignity Health president and CEO who will be sharing the CommonSpirit CEO role with CHI CEO Kevin Lofton, said in prepared remarks.

Merger talks, which began in October 2016, were expected to span a year but the organizations ran into a series of setbacks. Minutes from Dignity’s board meetings in 2017 detailed concerns that executives and directors had about CHI’s financial position. The prospect of diminishing financial returns loomed as the deal dragged on and morale fell.

“Everyone is looking at this one because the merger, on the surface, isn’t obvious,” said Kevin Holloran, a senior director with Fitch Ratings. “They are watching to see if this is a new paradigm we are looking at.”

The two parts of CommonSpirit Health

The deal drew attention not only across the industry, but scrutiny from the Catholic Church as well. It received an unfavorable moral analysis from John Haas, president of the National Catholic Bioethics Center. The Catholic Church expressed concerns about abortion, physician-assisted suicide, sterilization and other services that must be separated when Catholic and non-Catholic hospitals merge. The Vatican ultimately signed off in October though.

The California Justice Department conditionally approved the merger Nov. 21, marking the final major regulatory nod.

The California Justice Department told the health systems that they must maintain emergency and women’s healthcare services for 10 years after the deal closes. The system must notify the department if it plans to change those services between years six and 10 so the Justice Department can assess community impact. All but one of Dignity’s 15 non-Catholic hospitals will operate under a separate Colorado-based not-for-profit corporation, allowing it to continue medical services such as post-delivery tubal ligations, which are deemed immoral by the church. A coalition of advocacy groups raised concerns about limiting reproductive health services, care for LGBTQ patients, or services for low-income and underserved communities.

The agreement also stipulates that CommonSpirit must support individuals who are homeless and co-locate, coordinate and integrate health services with housing across its California footprint. CommonSpirit will need to earmark $20 million over six years for the cause and partner with local governments and not-for-profit organizations.

The California Justice Department also required the health system to provide free care to patients earning up to 250% of the federal poverty level, among other mandates.

While the CHI-Dignity combination creates a unique footprint, it continues the trend of large health systems pursing mergers as a means to leverage scale. The number of deals last year hit 1,182, exceeded 2017’s total by 14.4%, according to PricewaterhouseCoopers. Quarterly deal counts have consistently exceeded 200 since the fourth quarter of 2014 and 250 since 2017’s third quarter, PwC data show.

More health systems are taking a regional approach as they consolidate. Advocate Aurora Health in Illinois and Wisconsin; Baylor Scott & White Health and Memorial Hermann Health System in Texas; and Boston-based Partners HealthCare and Care New England Health System in Rhode Island each aim to team up to build out particular service lines and save on purchases, among other ambitions.

The high pace of mergers continues to draw scrutiny, especially around the propensity to raise prices and diminish quality. Large systems that have duplicative IT systems, redundant leadership roles, and higher legal and consulting fees are especially susceptible.

If merging hospitals are in the same state but 30 to 90 minutes apart, prices on average increase by 7% to 10%, according to a 2016 study conducted by Northwestern, Harvard and Columbia universities. But there were no significant price changes resulting from mergers between hospitals across broader areas. CHI and Dignity point to that data point given that their hospitals’ service areas do not overlap. That being said, cross-state mergers can raise prices if the same insurers are dominant and if employers have workers across the combined footprint, and thus should be closely scrutinized, according to the study.

And the issue is likely to gain attention in Washington, D.C. Rep. David Cicilline (D-R.I.), chair of the House Judiciary Committee’s panel on antitrust issues, has been focused on monopolies and the impact on prices. He’s warned that he’s going to take a hard look at hospital mergers.

Executives claim that scale will help them save on vendor contracts, but those savings are diluted in far-flung organizations, research shows. Horizontal hospital mergers only saved acquired hospitals $176,000, or 1.5%, annually on average, which represents only 10% of what is claimed in the merger justification, according to a working paper from academics at the University of Pennsylvania’s Wharton School who analyzed about 80 mergers. Those savings predominantly came from neighboring hospitals or systems that bundled expensive physician-preference items.

“Although these big hospital chain mergers don’t happen that often, what we do know about these mergers is that we should be skeptical,” said Stuart Craig, an economist at Wharton and an author of the paper. “They often have a large impact on consumers because they touch a lot of markets.”

A lack of market overlap seems fairly innocuous to regulators, but it also potentially points to a lack of cost savings, he added.

“Even though the justification for a lot of these mergers is that they lower costs, we don’t really see that,” Craig said. It would be hard for CHI and Dignity to save more on supplies because they already have a lot of bargaining power, he said.

Healthcare executives also argue that scale will increase their leverage with insurers, but those savings don’t typically translate to lower costs to consumers, economists contend. When consolidation leads to providers obtaining higher prices, the impact ultimately falls on consumers through higher premiums, increased out-of-pocket costs or lower wages, Martin Gaynor, professor of economics and health policy at Carnegie Mellon University, told Congress last year. In addition to higher prices, Gaynor and his peers’ studies concluded that quality drops along with competition.

Dignity has stood on relatively stronger financial footing than CHI. CHI saw its operating losses widen to $593.4 million in 2017 from $371.4 million in 2016, as it tried to rectify years of overspending when the organization went on a physician group buying spree. CHI rebounded in 2018, narrowing its net loss to $276.7 million after the organization cut costs and improved its revenue-cycle management. In the first quarter of its fiscal 2019, it reported an operating loss of $73.4 million, down from a $77.9 million operating loss over the period prior. CHI’s $148.4 million of non-operating gains more than offset its first-quarter loss.

CHI looks more like an amalgamation of systems while Dignity seems to have a more unified structure, Fitch’s Holloran said.

“CHI on its own is a very large organization that’s spread out and has struggled operationally,” he said, citing the Kentucky, Houston and Nebraska markets where the system expanded very quickly. “Just having size and scale doesn’t mean you are successful. It means you have to up your game and manage all those moving parts better.”

Dignity reported operating income of $529.3 million in 2018, up from an operating loss of $66.8 million in 2017. In the first quarter of 2019, it reported $46 million of operating income up from a $132 million operating loss over the period prior.

The companies have about $10 billion in debt and officials said they plan to combine their credit groups in three years. Dignity is rated A with a negative outlook and CHI is rated BBB+ with a positive outlook, and a merged entity would likely land somewhere in the middle, analysts said.

“The biggest challenge is probably the culture,” said Martin Arrick, a managing director in Standard & Poor’s not-for-profit healthcare group, adding that Dignity’s management structure has worked better than CHI’s.

Dean and Lofton are splitting the CEO seat. Dean will have authority over operations and clinical, financial and human resources functions. Lofton will oversee advocacy, compliance, digital, information technology, international business, legal services, philanthropy, mission, sponsorship and governance, and system partnerships.

Advocate Aurora Health divided up the CEO role, as did Hackensack Meridian Health for about 2½ years. Notably, Hackensack’s succession plan was developed when the deal was completed in 2016. John Lloyd, former co-CEO of Hackensack who retired in December, said the structure worked well because each organization had different strengths. Others cautioned that the dyad model could disrupt culture, decisionmaking and continuity.

Typically it only works well in the short term, Tom Giella, chairman of healthcare services for Korn Ferry, told Modern Healthcare in late 2017 when CHI and Dignity signed a definitive agreement.

“It is a good short-term solution while they figure out integration and people and cultures, but ultimately you have to pick your leader. I think that will come in two years-plus,” said Giella, adding that otherwise, culture and egos can clash.

More than half of CommonSpirit’s executive team is currently with Dignity, 38% is from CHI and 8% is external, according to a recent public filing. CommonSpirit has a multiyear lease in Chicago’s West Loop. The companies will maintain their corporate offices in Denver and San Francisco for the foreseeable future.

Regulators are taking a closer look at large cross-market mergers, and the CHI-Dignity deal could ramp up that scrutiny, Arrick said. Still, the underlying drive to reduce administrative overhead, scale IT spending and increase access to capital is not going away, he said.

“The bigger issue is that there are so many issues with hospital profitability—it’s like death by a thousand cuts,” Arrick said.

Tara Bannow contributed to this report.