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Fewer independent hospitals can weather operating headwinds

When Nanticoke Memorial Hospital first lost its Medicare-dependent hospital status in 2014, it checked the first of several criteria that would chart the independent Seaford, Del.-based hospital’s future.

The CMS declared that Delaware, New Jersey and Rhode Island no longer had areas that qualified as rural under its new rules, which meant that hospitals in those states would have to earn a rural reclassification to qualify for the higher reimbursement rate. Nanticoke went without Medicare-dependent hospital funding for periods of time, which made it harder to operate independently.

Lower Medicare rates contributed to six consecutive months of operating losses through the first half of fiscal 2019, one of several signs that Nanticoke needed to search for a partner, CEO Steven Rose said. The organization also couldn’t produce a capital plan and faced the reality that fewer physicians wanted to work there.

“We reached this situation because of the precarious nature of the federal government and the CMS,” Rose said. “They took away our Medicare-dependent hospital status, then the rural floor adjustment, and changed 340B as the federal government ratcheted down. So we set out to look at partnerships—we didn’t want to wait for crisis mode.”

Stand-alone hospitals’ financial situations are increasingly tenuous. More than half the nation’s stand-alone hospitals (53.2%) have lost money on an operating basis for each of the past five years, which is more than twice the share of system-owned hospitals (25.9%), according to an analysis of Modern Healthcare Metrics data.

Rural stand-alone hospitals are most at risk, with 60.5% having lost money on an operating basis in each of the past five years, compared with 42% of their urban counterparts. Rural stand-alone hospital margins in 2017 stood at negative 17.9% compared with negative 5.6% for those in systems. Urban stand-alone hospitals’ operating margins were negative 17.2% compared with negative 10.2% for those belonging to systems.

Independent hospitals are particularly vulnerable because they stand to lose patients to post-acute settings like nursing homes or hospices. The average length of stay at stand-alone hospitals increased sharply in the past five years while it declined at system-affiliated hospitals. The average weighted length of stay at stand-alone hospitals rose by 6.4% between 2012 and 2017 while the average length of stay at system-based hospitals fell 23.5%, meaning independent hospitals are reliant on fewer patients staying longer. Stand-alone hospitals saw their occupancy rates fall to 43.6% in 2017 from 53.9% five years earlier, while system hospitals saw their occupancy rates fall to 53.7% from 61% over the period.

Nanticoke’s search for a partner took it to Salisbury, Md., home of Peninsula Regional Medical Center. The operators of independent hospitals signed a letter of intent to affiliate in January. Peninsula Regional also partnered with the McCready Foundation, a two-bed facility in Crisfield, Md., that will be converted to a free-standing facility. McCready also has a skilled-nursing facility, an assisted-living arm and intermediate-care operations.

The membership substitution agreement means Peninsula Regional will become the sole corporate member of Nanticoke. Peninsula will operate under two boards with executives from both organizations, one of which is focused on quality and the other on strategy.

The combination will allow them to scale their population health models, recruit and retain employees, and expand ambulatory and telehealth operations, executives said. “The number of independent hospitals is shrinking by about 1% a year,” Peninsula Regional CEO Steven Leonard said. “This provides us the scale that is necessary to evolve.”

More independent hospitals are joining larger systems to cope with these financial headwinds. Nearly three-quarters of all hospitals were part of multihospital systems in 2017, up from 70.4% in 2012, according to Metrics data.

All signs point to independent hospitals going away

The Metrics data are supported by other research. There have been 380 rural hospital mergers between 2005 and 2016, with some merging more than once, according to the University of North Carolina Cecil G. Sheps Center for Health Services Research. Ninety-seven rural hospitals have closed since 2010.

Independent government-owned hospitals, many of them in rural areas, had an average annual operating margin of negative 16.6% and a $15.8 million operating loss in 2016 compared with a negative 7.9% operating margin and $8.4 million operating loss for their system-owned peers, according to a white paper from Healthcare Management Partners, Waller Lansden Dortch & Davis, and Taggart, Rimes & Graham. Those in five Southern states—Alabama, Arkansas, Mississippi, Tennessee and Texas—are far worse, reporting an average negative 41.9% operating margin and a $26.6 million operating loss.

Part of the problem is that commercial insurers pay consolidated health systems more, said Lee Domanico, CEO of Marin General Hospital, an independent organization in the San Francisco Bay Area.

Marin General has performed better since it split from Sutter Health in 2010, Domanico said. It has been 330 days since its last serious safety event compared with one reported every 30 to 45 days prior. Its quality grades have improved and Marin General is no more expensive to operate than its larger counterparts, he said. “The evidence shows that consolidation doesn’t lead to improved quality, safety or efficiencies,” Domanico said. “It primarily leads to better pricing.”

Marin General benefits from being one of only two major hospitals serving the community. It is owned by the Marin (County) Healthcare District and supported by taxpayers. Its independence and local control also helped secure a number of partnerships and affiliations, Domanico said.

For instance, Marin General recently expanded clinical collaborations through an affiliation with UCSF Health. It will provide an influx of capital to further develop ambulatory sites, spread IT costs over a wider patient base and lower its risk profile, Domanico said.

Still, rural hospitals will feel pressure to consolidate, he said.

“As the industry continues to change, the ultimate question is how many hospitals will be required in the country,” said Leslie Hirsch, interim CEO of St. Peter’s Healthcare System in New Jersey.

St. Peter’s is the last independent system in Middlesex County, one of the most competitive areas in the U.S., Hirsch said. The county’s nine other hospitals are affiliated with Hackensack Meridian Health, RWJBarnabas Health or Penn Medicine.

St. Peter’s has been seeking a partner to help it compete with area systems. It completed a $20 million turnaround last year as it boosted a negative operating margin to 2.6% by improving its supply chain, tweaking its labor structure and employee healthcare benefits through a partnership with other area systems and working closely with physicians to reduce length of stay, among other improvements. But it’s likely not enough over the long term, Hirsch said. “It’s definitely harder to run an independent hospital today than it was in the past.”

Regional policy board discussions coordinated by industry associations reveal that industry experts expect there to be at least 500 fewer hospitals required across the country; some even expect that to contract by 1,000.

Of all rural hospitals, about 21% or 430 across 43 states, are at high risk of closing, according to a new report from Navigant. The states with the highest percentage of rural hospitals at risk are Alabama at 50%, Mississippi at 48%, Georgia at 41%, and Alaska and Maine at 40%, according to the analysis.

“These were built at a time when inpatient utilization was much higher,” said Dr. Daniel DeBehnke, a managing director at Navigant, adding that declining populations and the migration to ambulatory care have compounded their problems.

There are a range of proposed policy changes that could help rural and independent hospitals survive. They include using global budgeting and overhauling the Medicare wage index and rural floor provision. New debt refinancing models, improving the funding and reimbursement of telemedicine, and passing the Rural Emergency Acute Care Hospital Act could also help.

But in the meantime, independent hospitals don’t have the time to wait for potential solutions. “Every year you see margins eroding,” Nanticoke’s Rose said. “We realized there was an awful lot to be gained by being part of a larger group.”