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E-Briefings – Volume 16, No. 2, March 2019

Welcome to The Governance Institute’s E-Briefings!


This newsletter is designed to inform you about new research and expert opinions in the area of hospital and health system governance, as well as to update you on services and events at The Governance Institute.


Click here to download the full PDF version.

The Board’s Role in Evaluating New Revenue Stream Opportunities


Hospital and health system leaders are increasingly being asked by management teams to consider new opportunities and ventures that, until recently, would not have seemed like logical extensions of a healthcare provider’s core business. This article explains why as these opportunities arise, boards must consider their role and obligations.

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By Brad Dennis, Associate, Megan Rooney, Partner, and Dale C. Van Demark, Partner, McDermott Will & Emery LLP


Key Board Takeaways


  • Seek outside guidance when presented with ventures outside the board’s knowledge and experience.

  • Understand why the organization should pursue an opportunity; don’t do it just because you can.

  • Confirm that the opportunity furthers the organization’s purpose and, where applicable, genuinely fits into the organization’s mission, vision, and values.

  • Be aware of key stakeholders and obligations to such stakeholders, and recognize when undue influence may be clouding the decision.

  • Don’t be afraid to cut your losses when an opportunity strays from the organization’s original understanding and goals.

Hospital and health system leaders are increasingly being asked by management teams to consider new opportunities and ventures that, until recently, would not have seemed like logical extensions of a healthcare provider’s core business. However, in today’s environment of shrinking margins, new competition, and evolving delivery and payment systems, hospitals and health systems are expanding their views to consider ventures, including, for example, weight loss clinics, community gyms, healthcare technology start-ups, and even on-campus hotels. As these opportunities arise, boards must consider their role and obligations.


1. Understand the Opportunity and Whether Your Organization Is Best Suited to Pursue It


In recent years, healthcare has become a hotbed for new and innovative ideas and ventures that push the limits of what we thought was possible. As such, boards should expect to be presented with opportunities that challenge existing perspectives and present novel ideas and capabilities. This means that boards need to be prepared to analyze proposals outside their expertise and put in the extra time needed to make thoughtful and well-informed business decisions.


Being prepared has both structural and operational components. Boards need to be thoughtful about their composition, making sure that current and future board members possess the needed experience and expertise required to effectively evaluate “outside the box” proposals. Furthermore, boards—with assistance of management—need to know when to seek outside help from consultants and experts. Management and boards should be realistic with respect to their capabilities and expertise. Consultants and outside counsel can fill knowledge gaps and help boards understand not only the keys to success for a venture, but also the risks involved.


2. Analyze the Risk versus Reward


In addition to being prepared to analyze an opportunity technically, a board must also understand why it would pursue the opportunity. Understanding the “why” requires situational awareness of both the organization and the larger healthcare industry. This requires a clear grasp on the organization’s patient care and financial performance, technology capabilities, and manpower, among other factors. It also requires an understanding of market trends, legislative and reimbursement changes, developments in the way patients engage healthcare, and the emergence of new competitors. Having this scope of awareness allows the board to have a candid conversation about whether a given proposal can actually result in a meaningful solution or outcome and whether the attendant risks are worth taking.


For example, a health system may be presented with an opportunity that includes short-term costs without any tangible short-term gain—such as financial investment in a technology innovation center. The health system might decide to pursue the opportunity if other factors are compelling enough to outweigh the cost. To make that decision, a board must understand what the innovation could achieve and whether that result is a value to the health system.


Although new opportunities could produce valuable results, boards must filter even the strongest opportunities through the lens of the organization’s long-term strategic plan. Discipline in decision making is critical. Boards should not, however, be afraid to use new opportunities to challenge their thinking and, potentially, modify the strategic plan to adapt to market changes and opportunities. Although strategic plans operate as a guideline, they should never handicap the organization from doing what it has to in order to survive, so long as changes to the plan are done in a thoughtful manner and not simply in reaction to an opportunity.


3. Think About Mission


The board’s decision must always be grounded in the mission, vision, and values of the organization. As noted above, many new opportunities focus on generating new revenue streams. Although hospitals and health systems need to focus on revenue in challenging times, the mission of the organization requires that the board do more than focus on the financial health of the organization. Regardless of whether it is in the context of a long-term strategic plan or a one-off innovative opportunity, a board must always bring its thoughts back to organizational mission.


4. Consider Your Stakeholders


Hospitals and health systems are accountable, legally or otherwise, to a number of different stakeholders, including patients, employees, the medical staff, and the community. To appropriately identify and process its obligations to stakeholders, boards should discuss the stakeholders involved in each opportunity that it reviews and what role each of the stakeholder obligations should play in its decision.


Take, for example, an employed physician who approaches a hospital with a new health-tech application that the physician wants the hospital to adopt and roll out to its employed physician group. In considering the opportunity, the organization must consider how it may impact patients (e.g., patient safety and data privacy), change the hospital’s relationship with the employed physician (e.g., offending the physician if the opportunity is declined or creating a new dynamic if the employee becomes a business partner) and other physicians (who may feel emboldened or left out), and further the charitable obligation to the community (e.g., generating new revenue to preserve essential services, or using the community’s asset to create private benefit for the physician). While evaluating these factors, the board and management must remain unbiased. Consider, for example, how the above scenario might be perceived if the physician presenting the opportunity is one of the system’s highest productive providers, or she has a contract renewal right around the corner.


5. Stay Involved and Be Prepared to Revisit the Decision


New revenue stream opportunities, by their very nature, will evolve throughout the organization’s efforts to review, evaluate, and act on them. As such, boards should be prepared to take a more active role in monitoring progress and confirming that they continue to understand the opportunity, and that the opportunity continues to make sense for their organization. Although it is appropriate for management to continue to take the lead on day-to-day efforts, increased board involvement may mean requesting more frequent updates, and increasing the number of approval checkpoints. Boards should not shy away from making the difficult decision to change course if the opportunity is not achieving, and appears unlikely to ever achieve, the anticipated value. Disciplined decision-making is critical.


The Governance Institute thanks Brad Dennis, Associate, Megan R. Rooney, Partner, and Dale C. Van Demark, Partner, McDermott Will & Emery LLP, for contributing this article. They can be reached at bdennis@mwe.com, mrooney@mwe.com, and dcvandemark@mwe.com.



Government-Affiliated Hospital Business Combinations: The Governance Dynamic


This article explores Indian River Medical Center and Indian River County Hospital District's combination with the Cleveland Clinic and how leaders of governmental hospitals that wish to consider ownership change should focus heavily on governance issues, rather than organizational and legal complexities.

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By James Burgdorfer, Principal, Juniper Advisory


Key Board Takeaways


Leaders of governmental hospitals that wish to consider ownership change should focus heavily on governance issues, rather than any organizational and legal complexities that they face. Most resistance-to-change and transaction difficulties have resulted from leadership of the governmental entity and the hospital failing to act in a unified manner. Vero Beach’s combination with the Cleveland Clinic offers several suggestions for governmental hospitals considering ownership change:

  • The initial focus should be to encourage both governmental and hospital leaders to reach early agreement regarding the topic.

  • It is helpful to gain consensus among the two groups on several fundamental objectives for the health system.

  • Proceed in a collaborative manner with consistent governmental and hospital representation.

  • Work with legal and financial professionals to overcome legal and structural complexities.

  • Follow state sunshine laws assiduously and provide the public with regular updates on the process.

  • Utilize communications professionals.

  • Understand and confront the challenges of group decision-making; foster frequent interaction between leadership groups.

Indian River Medical Center (IRMC) and Indian River County Hospital District (IRCHD) in Vero Beach, Florida, joined the Cleveland Clinic on January 1, 2019. This business combination represents an extraordinarily positive outcome for the community of Vero Beach. It also stands in sharp contrast to the sluggish level of change in ownership and control being experienced by governmental hospitals nationally.


This article explores how IRMC and IRCHD were able to avoid hurdles that other governmental hospitals have encountered in attempting to join larger organizations. In particular, it focuses on the role that governance and social factors play in depressing openness to change and the ability to complete business combinations. An understanding of how IRMC and IRCHD managed certain governance and social dynamics in Vero Beach might be useful to other public hospitals considering change.


Governmental Hospital Structures


The range of state, city, county, district, hospital authority, and public trust governmental hospitals is wide. A common structure consists of community 501(c)(3) organizations that lease their facilities from governmental units. Government entities exert their ownership control in differing ways, ranging from tight control by appointing the hospital board and approving all decisions, to loose control with the governmental entity fairly removed from the 501(c)(3). Other governmental hospitals are made up of single government entities that own land, buildings, equipment, and the hospital business; these take many organizational forms.


Challenges Associated with Governmental Ownership


Many governmental hospitals might benefit from ownership change; in certain instances it is acutely needed. They face the same pressures to improve quality and lower costs that challenge most hospitals and health systems. In addition, they are confronted with complicated governance structures and disclosure requirements along with restrictions on capital. Many governmental hospitals were formed in the early- and mid-20th century when far different transportation and hospital industry structures were prevalent, accounting for their sometimes anomalous locations and structures.


Resistance to Change


Despite the exigency of these factors, change within governmental hospitals has been occurring at a slower pace than experienced by other non-profit ownership groups. Change is often the most difficult challenge for community hospital boards to address. Governmental hospitals have even greater difficulty than other non-profit ownership forms. The unique legal and political features found in governmental hospitals are often blamed for this.


In circumstances where the 501(c)(3) hospital leases assets from the governmental entity, two distinct groups of decision-makers are present. Difficulty in addressing change often results from the divergent perspectives of these two groups. Community hospitals typically have self-perpetuating boards whereas governmental units have identified owners and elected board members. Publicly elected officials have obligations to their constituents as well as to the community’s healthcare needs, potentially creating conflict with hospital leaders. In addition, differing understandings of authority can cause challenges between these two groups. When the governmental entity owns assets and controls operations, political considerations can arise because the governmental entity’s mandate includes constituencies beyond healthcare.


Difficulty in Executing Transactions


Given these complexities, it is not surprising that government hospitals have made fewer attempts to consider ownership change. Those that have done so have experienced a higher incidence of protracted, cancelled, or failed transactions. Along the way, much organizational disruption and delay resulted.


Difficulties have occurred during both of the principal phases of transactions involving change in ownership (i.e., selecting a partner and structure of choice, and negotiating transaction agreements). Group decision-making can be very difficult with one board; the need for two groups to reach the same choice of a partner and approve the same agreements exacerbates the challenge. Many infrastructure privatizations have not worked well. As a result, there is considerable resistance to outright sales of assets by governmental entities, and they frequently enter into long-term leases of real assets.


To a certain extent, these challenges relate to specific governance, political, legal, business, and regulatory considerations associated with government hospitals. It is tempting to attribute the many transaction missteps that have occurred to these complexities. However, in Juniper’s observation of this market, transaction difficulties most often result from disagreement between government and hospital leaders on goals, objectives, and processes early in any consideration of change or a transaction. Often, this includes a lack of any agreement on these issues at all. This is the central difficulty across all forms of governmental hospitals.


How Vero Beach Overcame Challenges


For many years, IRCHD and IRMC experienced a very typical relationship found in governmental hospitals. There were frequent disagreements concerning strategic and operating decisions and, fundamentally, which group was in control. They also experienced many of the legal and organizational complexities that one could find in governmental hospitals (e.g., regulatory and statuary approval processes and public disclosure requirements). This constrained IRMC’s ability to develop service lines and other medical offerings that Vero Beach’s residents sought. Further, Sunshine rules that required board and committee meetings to be conducted in public had an inhibiting impact on change and innovation. As a result, there was little consideration given to potential changes to ownership structure.


Collaborating and Considering Change


Despite their history and challenging structure, the opportunity for change came when the chairs of both boards met and shared their concerns regarding the future. They saw a way to begin to work together. This rapport between the leaders of the boards led to an ability to reconsider the past. Both were aspirational and understood the limitations of the current structure.


At the outset, these leaders agreed to a collaborative approach to considering change that included hospital, district, and foundation representatives. Once they had this breakthrough, a collaborative group quickly exhibited a willingness to listen to external observers of the hospital industry (who were critical of governmental control) and consider change. This allowed the leaders of these three groups to actively consider the potential benefit of ownership change. Finally, they instituted a formal assessment of their situation with the help of a consultant over a several month period, and then retained Juniper to assist in a partner search. Most importantly, the difficult job of reaching agreement on approach and objectives regarding the potential for change in ownership was accomplished before moving forward.


Overcoming Transaction Challenges


Once equipped with a better understanding of their circumstance, the decision to consider change was aided by the recognition that both boards had the same essential objectives. Simplifying these into quality healthcare, financial wherewithal, and the ability to thrive under any future healthcare environment helped both boards to recognize that their goals for the future were essentially the same.


After deciding to approach the market of potential partners, it was important to determine how best to adhere to Florida’s Sunshine Law. A set of carefully considered logistical and communication tactics was designed to ensure careful compliance. This was challenging from a process point-of-view because many of the elements of for-sale processes are commercially sensitive. All proposals were made available to the public throughout the process. In addition, Vero Beach instituted a communications strategy aided by an external communications advisor. Selecting a partner involved two boards arriving at the same conclusion twice. First, regarding the selection of four finalists and, ultimately, deciding on the partner of choice.


The transaction between IRMC and the Cleveland Clinic was structured as a membership substitution. Simultaneously, IRCHD entered into a new, modified and extended lease agreement with the Cleveland Clinic. Input and approval on both agreements was needed from both boards. This elongated the transaction process but was successful because of early agreement amongst the groups regarding the need for, and intent of, this change.


Conclusion


Others considering a change of this sort should expect a transaction involving a governmental hospital to take longer than one involving a community hospital. This is especially true at the front and back ends of any similar process. At the front end, considerable effort and time is required to establish a collaborative process, and at the back end, extra steps are required for multiple approvals. Importantly, the market-clear process need not, and should not, be elongated relative to a similar transaction involving only a community hospital.


The Governance Institute thanks James Burgdorfer, Principal with Juniper Advisory, for contributing this article. He can be reached at jburgdorfer@juniperadvisory.com.



Bundled Payments: An Important Discussion for the Board


Bundled payment contracting is replacing fee for-service reimbursement at an accelerated rate and more importantly, bundling an institution’s reimbursements with those of the medical staff aligns incentives both clinically and financially. This article addresses these important issues as an outline for board discussions.

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By William C. Mohlenbrock, M.D., FACS, Verras Ltd.


Key Board Takeaways


Questions for the board to consider around bundled payments include:

  • Which of the clinical services’ market shares have held steady over the past five years?

  • Has the board discussed bundled payments with the executives and medical staff?

  • Are local employers satisfied with their healthcare costs? If not, would they be interested in bundled payments as an option to control costs?

  • Which of the clinical services have the highest quality and are the more cost-efficient as a place to begin a bundled payments discussion?

The time for hospital board members to discuss bundled payments with their executives and physicians is now. Bundled payment contracting is replacing fee-for-service reimbursement at an accelerated rate and more importantly, bundling the institution’s reimbursements with those of the medical staff aligns their incentives both clinically and financially. This article addresses these important issues as an outline for board discussions.


Hospital and Physician Participation in Bundled Payment Models


After Medicare was implemented in 1965, the seniors’ program gradually expanded to other patient groups, as well as covering 55 percent of all state-sponsored Medicaid costs. To ostensibly control quality and costs, in 2010 the federal government created innovative delivery models designed to stimulate clinical and financial integration between hospitals and physicians. Four Bundled Payments for Care Improvement (BPCI) models were developed to encourage voluntary physician–hospital integration. These public bundled payment models have accomplished integration, and importantly, relaxed some prohibitions on physicians’ abilities to share in the net savings.


In addition to these public initiatives, some physicians have been participating in private risk-bearing models with self-insured employers and third-party payers to share in net savings, not prohibited by law. These cost-containment models offer physicians the opportunity to stabilize their falling incomes, and both private and public risk-bearing initiatives are having a cost-containment effect. They successfully incentivize hospitals and health systems to collaborate with their medical staffs and increase physician participation through financial rewards.


The Department of Health and Human Services (HHS) has therefore developed a delivery model that transfers financial risks to specific hospitals for treating one of the most expensive groups of Medicare patients—total hips and total knees. The Comprehensive Care for Joint Replacement (CJR) model is the first delivery model to shift financial risks to hospitals for an entire surgical episode. Under CJR, if quality is improved and cost savings are realized, physicians are able to share in the net savings, but, unlike hospitals, doctors are exempt from accepting the financial risks. Hospital administrations and boards are placed at extreme risk because they are responsible for all resources consumed by one of many hospitals’ most lucrative patient groups. The risk occurs if a hospital’s costs of treating patients during the CJR episode are higher than those actually paid by Medicare. Such cost overruns must be reimbursed as penalties to Medicare and include the total costs of inpatient care, physicians’ fees, and all resource consumption during the 90-day post-discharge phase. Some health policy experts, such as Harvard’s Michael Porter, believe that these models offer the best hope of controlling U.S. healthcare costs.1


Quality and Financial Outcomes Are the Board’s Responsibility


Since the Darling decision of 1965,2 board members have been responsible for the clinical quality and financial outcomes of their hospitals and health systems. To improve the organization’s performance the board should acquire clinical and financial information to quantify objectively defined outcomes of each clinical service (e.g., cardiology, orthopedics, etc.) and medical staff members.3 Documented variations in clinical and financial outcomes for high-cost procedures are large, usually hundreds of thousands of dollars per case. Board members need to know where their hospital or health system ranks using these readily available metrics. In addition to total joints, other orthopedic and cardiac procedures such as stents might be beneficial to offer employers as bundles. Knowing where the institution ranks among the competition for these procedures is important. With knowledge as to their hospital’s competitive position, board members are in a particularly leveraged position to promote value-based healthcare delivery to hospital executives and physicians and in turn to the marketplace. They are often employers and decision makers for community businesses that wish to control their costs by pursuing bundled payments contracting.


Bundled Payments Promote Quality and Financial Improvements


For years it has been noted that the more integrated organizations such as Mayo Clinic are able to control their costs more efficiently than less integrated providers. All doctors and administrators in these integrated models are equally at risk, both financially and clinically. To promote integration in other hospitals, Medicare implemented the previously mentioned bundled payments initiative for total joint replacement (TJR). Moreover, for a small number of hospitals, the program was made mandatory, which will probably be expanded to other such programs.


In these models, the doctors and hospitals are more closely aligned, and intense pressures are being placed on them to measure and improve quality and costs. Purchasers are demanding value, just as they do from all other product and service suppliers on whom they spend their hard-earned dollars. Bundled payments are a powerful incentive for physician–hospital collaboration and in view of the recent relaxation of some financial sharing prohibitions, many hospitals and health systems will be using bundles as a means of sharing any accrued net savings as physician incentives to improve quality and cost-efficiencies. Physicians can generate sufficient resources to offset some of their overhead costs if they collaborate with the hospital to maximize inpatient quality and cost-efficiencies through physician-directed practice pattern optimization.


For these reasons, physicians need to consider the benefits of the bundled payments structure. When reliable clinical data are effectively used to create net savings, it may be one of the only times in memory when doctors are able to receive increased reimbursements for practicing high-quality care. Doctors’ overhead costs are increasing, and insurance companies and Medicare reimbursements are not keeping up with the inflated costs. Net saving distributions with the hospital may be a welcome financial benefit.


Bundled Payments Focus the Hospital on Its Clinical Strengths


The optimal benefit of bundled payments will be realized when self-insured employers contract with hospital administrations and boards that are motivated to work with their medical staffs to share financial risks and net savings. Bundled payments are the basic structures around which regional, value-based healthcare delivery systems are being formed. The downside of not considering bundled payments as an option is the possibility of the hospital finding itself at a competitive disadvantage as regional employers send patients to other facilities in the area or to other countries as medical tourists. Every sector of our society benefits from market-based competition, and healthcare will be no different when hospitals and physicians are able to share net savings by documenting high-quality, cost-efficient medical care.


Over the past three decades, there has been a push toward integrated healthcare systems. Some healthcare organizations such as Kaiser and Cleveland Clinic have successfully provided virtually all medical services. Yet every hospital cannot provide excellent service in all specialty areas, as many executives and boards have felt obligated to do over the past few years. Community hospitals have undertaken huge expenditures to develop new clinical services with which to compete in their city’s or regional medical arms race. Over the last three or four decades, it has not escaped local employers’ attention that the only construction cranes in town were for new hospitals or hospital wings that add some new “center of excellence.” Moreover, well-meaning philanthropists have poured billions of dollars into hospitals and health systems to create clinical services that may or may not be fully utilized.


A secondary but important quality benefit is the ability of value-based competition to transform hospitals and health systems into “focus factories.”4 This involves each hospital eliminating its less inefficient services and focusing on those clinical services that the enterprise determines are their strongest clinical areas. Boards might find it productive to prepare for the future by having a discussion around bundled payments that focus the institution’s precious resources for both financial and quality reasons.


Conclusion


The HHS bundled payment model for total joints has established a means through which public and private purchasing will likely replace fee-for-service contracting for a significant number of high-cost procedures and conditions. Boards should consider discussing how their institutions will position themselves in the forefront of this growing competitive model. Bundles are equally important because of the integration of financial and clinical incentives they foster between the institution and its medical staff. In many communities, board members are the natural ties between employers who want their companies to contract for the highest-quality, most efficient care and their institution and clinicians who want to provide it. There are only winners in these transactions and the time for discussions is now.


The Governance Institute thanks William C. Mohlenbrock, M.D., FACS, Founder and Chief Medical Officer, Verras Ltd., for contributing this article. He can be reached at bmohlenbrock@verras.com.



1Michael Porter and Robert Kaplan, “How to Pay for Healthcare,” Harvard Business Review, July–August 2016.

2Darling v. Charleston Community Memorial Hospital, 33 Ill. 2d 326, 211 N.E.2d 253, 1965 Ill. LEXIS 250, 14 A.L.R.3d 860 (Ill. 1965).

3Bill Mohlenbrock, M.D., The Handbook of Healthcare Value: How Self-Insured Employers and Patients Can Contain US Healthcare Costs, 2018.

4Regina Herzlinger, Market-Driven Health Care, New York: Perseus Books,1997.


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