A "Perfect Storm" Drove Independent to Merge With Hospital

Kari Young, CPA

As many hard-pressed physician practices have been doing in the present healthcare environment, our oncology practice also had to take a hard look at our operational design, strategy for the future, and sustainability. Our assessment resulted in the difficult decision to leave private practice and merge with one of the hospital systems in our city. Many people have asked why we would make such a traitorous decision. Independence is still highly valued by many physicians, and “selling out” to a hospital is considered analogous to selling one’s soul to the devil. As you may imagine, various factors led up to the final decision, including marketplace structure, payment changes, rising operating costs, and regulatory requirements. Our options were limited, and most were not very palatable, but while all appearances indicate a failure to thrive, the end result was a brilliant exit strategy for our owner—physicians.

In a city of under 1 million people, we had more than our share of competing hospitals. There were plenty of physicians in some specialties— including oncology—and not enough in others. The oncology competition came from a large nonprofit hospital system (Hospital A) related by common ownership to a private insurance plan, a teaching hospital (Hospital B) with a robust research program, and another independent oncology practice. The fourth entity that played a major role in our healthcare market was a for-profit hospital (Hospital C) that owned a radiation oncology department and, for a period of time, a health plan that gave it a competitive advantage over independents that were reliant on nonexclusive payer arrangements.

Change in Referral Patterns

Over the decade just ended, oncology care had evolved dramatically in the city. Hospital A built market share by creating a radiation oncology program and affiliating with a nationally recognized cancer program. Instead of partnering with the community by referring patients to existing oncology practices and inviting community oncologists to chair oncology committees, Hospital A began hiring medical oncologists and leveraging its owned health plan’s number of covered lives (an almost 50% market share) to the exclusion of community-based oncology. In the meantime, Hospital B ebbed and flowed as a competitor but managed to sign an exclusive agreement with Hospital C to provide medical oncology services. Hospital C realized fairly quickly that this agreement was detrimental to its other departments, including radiation oncology and inpatient admissions. It took a few years, but Hospital C eventually removed itself from the exclusive service agreement with Hospital B and began looking for a new oncology partner. It was imperative for the survival of community oncology that Hospital C not resort to the same strategy that Hospital A had implemented—building an oncology program from the ground up in direct competition with community oncology.As Hospital A continued to develop its own oncology program, we saw a persistent adjustment in the mix of payers with whom we were dealing. There were fewer and fewer patients with Hospital A’s insurance plan being referred to our practice, and that left us with a higher proportion of patients whose insurance plans did not cover expenses as broadly. In addition, we saw a change in patient mix, going from 60% hematologic and 40% oncologic disorders to more than 70% hematology patients. This further deteriorated our profitability. The exclusive service agreement between Hospital B and Hospital C’s insurance plan had an adverse impact on our revenue until Hospital C’s insurance plan reverted to an open provider network. Then Hospital C sold the insurance plan, and once again we saw another adjustment in payer mix.

Participation in Reporting Programs

At the same time, the Affordable Care Act (ACA) introduced Accountable Care Organizations (ACOs), and some of our marketplace payers jumped on that bandwagon, creating exclusive arrangements with providers for certain patient populations. Our organization chose not to join an ACO because of the payment risk, and this caused patient access restrictions. The ACA also created the unintended consequence of patients who moved to high-deductible plans and had no means to pay their out-of-pocket costs. These events—reduced reimbursement because of changes in payer mix, higher patient bad debt, payment delays, and the uncertainty associated with a move toward valuebased payment models—caused us to question our sustainability as a practice. At the same time, our costs continued to rise. To remain competitive by attracting and retaining talented, experienced physicians and nurses, we had to set up compensation plans that were quite expensive. As noted above, we were competing for resources with 3 different hospital systems and another independent oncology practice. Another huge expense was pharmaceuticals, the largest single cost category for an oncology practice. We worked hard to manage those costs, but ultimately we were at the mercy of how the pharmaceutical industry set prices. As we monitored and calculated the margin on our pharmaceutical purchases (the difference between purchase price and payer payment), we noticed that for more than half of the medicines we purchased, the payments received were below cost at Medicare rates. In addition, some of the payers started to implement specialty pharmacy requirements, step edits, and outright denial of prior authorization to administer certain therapies. This further deteriorated our ability to remain profitable.In 2007 we made the jump from paper patient records to an electronic medical records (EMR) system. It was an expensive endeavor but ultimately a good decision, and it positioned us well to participate in the Physician Quality Reporting System (PQRS) and the Meaningful Use (MU) reporting and incentive programs. We were also successful in becoming a Quality Oncology Practice Initiative—certified site. As you may be aware, PQRS and MU began as voluntary participation programs but over time evolved into punitive programs for failure to participate and/or not meeting the quality standards, so we were required to continue participating or suffer revenue degradation. In 2015 we applied for and were accepted into the Oncology Care Model program, which began in 2016. Participation in all these programs came at a significant cost in the form of human resources, administration, and reporting systems. There were EMR system maintenance and hardware upkeep requirements, new software add-ons needed for enhanced reporting, new servers needed every few years to keep up with the demands of software upgrades, and security hardware and software needed to protect systems from unauthorized access and cyberattacks, to name a few. Our information technology (IT) infrastructure accounted for over 10% of our total operating budget each year. Add to this the regulatory requirements of USP <797> and <800>, which were going to require a complete overhaul of our pharmacy and chemotherapy mixing area, and we were rapidly approaching unsustainability from a regulatory perspective.

Status Quo Was Not Sustainable

As with many physician-based organizations, clinicians come and go through the years. Ownership of the organization also changes over time. For any organization to remain viable, there needs to be a good succession plan to replace those who want to leave the organization, be it for retirement or other reasons, and a method to identify and cultivate new physician leadership. Time marches on, and personal plans change. Is the organization flexible and creative enough to adjust and evolve to accommodate the changing needs of its ownership? While we were losing clinicians, we had 2 physicians approaching retirement who wanted to cut back to part-time status. We had difficulty finding young oncologists with an entrepreneurial inclination or a desire to learn about the business of oncology. As described above, we also had a difficult time structuring an affordable compensation plan and call schedule to attract quality oncologists. Our ideal clinician staffing level was 7 to 8 full-time equivalents (FTEs). As clinicians left the organization and we were unsuccessful in recruiting good replacements, we hit the point of diminishing returns. This was a downward spiral that gained momentum and was increasingly difficult to salvage. At the time of our merger, we were down to 4 FTE clinicians.We certainly had options as we struggled through our challenges, and we carefully considered all of them, but many were just not acceptable. We could have continued as we were, maintaining the status quo to the best of our abilities. This did not appear to be sustainable beyond a couple of years, and we anticipated an endpoint that would have been ultimately undesirable. We looked at merging our practice with the other independent practice. There was a certain amount of logic to this approach, but we could not get past the significant cultural differences between the 2 groups. We were also facing payer contract restructuring, which would have lowered revenue for one or the other organization. We considered partnering with one of the 3 local hospitals. Hospital A was a closed door to us. Hospital B’s door was slightly ajar, but joining them was not a desirable option. Hospital C had the most potential as a partner, but there were also downsides to entering into a relationship with this particular entity. There may have been opportunities with a national oncology organization, but we did not pursue them. The final choice on our list was to simply close the doors.

We opted to partner with Hospital C. We began our relationship under a service agreement that ultimately evolved, over 2 and a half years, into an employment merger. While the process was somewhat painful, the result was a positive outcome for all involved. Greater than 95% of the physicians and staff were offered continued employment. There was continuity of care for the patients. The physicians who wanted to cut back to part-time hours were given the opportunity. All physical assets of the practice were purchased, including the IT infrastructure, the furniture and fixtures, and the pharmaceutical inventory. Over the life of the service agreement, we had the time and the resources to run out the practice’s accounts receivable without having to sell these accounts to collectors or write off significant balances. The only casualty was the name and structure of an independent, community-based oncology practice that had been in business for 40 years.

We were not unique in the set of challenges that faced our oncology practice, but we certainly had a perfect storm of circumstances that led to our ultimate decision to merge with the hospital. There were clear indications that our organization was not sustainable into the foreseeable future. We didn’t have enough flexibility to evolve into a viable practice that could combat the barrage of business challenges coming at us from all directions. Even though it was with a certain amount of sadness that we made the final decision to merge with the hospital, under the circumstances, it was the best decision for our organization. What began as indications of failure to thrive ultimately ended as a well-constructed exit strategy.