Hospital Groups Can Succeed

January 15, 2002
Practice Management
John W. McDaniel
Edited by: Paula Grant

Today, it’s hard to believe how eager hospitals were to acquire physician practices in the 1990s. They were spurred to engage in this buying spree largely by investor-owned physician practice management companies, which had themselves bought up physician practices in large numbers. Back then, the frenzy in many markets associated with buying medical practices and employing physicians created enormous competition among hospitals. Administrators thought they needed to own physician practices in order to be closely affiliated with physician groups that would refer patients to them. Physicians benefited greatly from this situation: Their practices were purchased at unreasonably high prices, and many of them received employment agreements rivaling those of professional athletes.

Practicing for Success
Now, most of the physician practice management companies (PPMCs) have gone out of business and many hospitals have been saddled with severe operational losses associated with their medical practices, forcing them to exit this line of business. After a decade of seeing what works and what doesn’t, the elements necessary to achieve successful hospital-affiliated practices can be defined as follows:
• A long-term strategic plan involving physicians and the hospital
• Alignment of professional and financial incentives for physicians and the hospital
• A reasonable compensation model that allows physicians and the hospital to succeed
• Active participation of physicians in governance activities
• Efforts on the part of administrative and physician leadership to meet mutual objectives.

Hospitals that have been successful at building physician practices have learned from the mistakes that PPMCs made when they were acquiring physician groups. Take the employment agreements the PPMCs inked with their physicians in the 1990s. Under these agreements, doctors were paid both a salary and a bonus; such contracts were attractive to the physicians but did nothing to boost their productivity.

Today, more knowledgeable hospital-affiliated group practices have sought to avoid that oversight by basing compensation on physician productivity. This productivity model is based on the relative value units (RVUs) of a physician’s efforts, a method many consider to be the true measure of an individual’s productivity. Under this model, physicians focus only on seeing patients and coding appropriately.
Gilmore Memorial Hospital is an example of a hospital that has been successful at building physician practices. Located in Amory, Miss.,

Gilmore was in a difficult market in the 1990s because large hospital systems were approaching local physicians as potential acquisition candidates. Seeking to sustain and grow business in this market, the hospital created Gilmore Clinic Services in 1994, in part to protect its market share from competitors that were seeking to acquire primary care practices. Gilmore also wanted to facilitate physician recruitment and develop a multispecialty group practice after it had established a primary care physician base. Gilmore has made strides toward achieving that goal; at this time, it employs 11 primary care physicians and seven specialists.

Gilmore acquired its first clinic in 1994, in Sulligent, Ala., with a solo physician. Today, the hospital operates nine clinics, with a total of 18 physicians and six nurse practitioners. Three of the physicians are in rural health clinics, located as much as 35 miles from the hospital, and six of the clinics are in the hospital’s primary service area.
Robert Letson, president and CEO of Gilmore, believes that the hospital has been successful at acquiring physician practices and making them successful from an operational standpoint because the hospital treats physicians as partners, not employees. In general, this factor seems to be the overriding reason for the success of hospital-affiliated group practices.

The employment agreements between the physicians and Gilmore include incentive production standards, and physician productivity is benchmarked against national standards established by the Medical Group Management Association with respect to RVU compensation and productivity. Will Wood, director of clinic services, who sought to change the structure of the physician contracts from being based on a salary and bonus, says that the new approach is consistent with the philosophy of treating physicians as partners because the RVU compensation model ensures that both parties have mutual objectives for practice growth.

As the hospital’s clinic services operations grew, it became feasible to develop a central business office for all practice operations, which it did in 1997. Several initiatives were undertaken to improve reimbursement systems, billing and collection processes, and accounts receivable management. Specifically, efforts focused on installing an automatic claim rebilling system that rebills unpaid claims every 60 days; and improving insurance verification and authorization at clinic sites, thereby decreasing the number of claim denials and rejections from insurers. These improvements were accomplished primarily by educating front-office staff on insurance verification and eligibility; obtaining correct demographic information on patients; and increasing efforts regarding over-the-counter collections of copayments, deductibles, noncovered services, and outstanding patient balances.

For fiscal year-end 2001, Gilmore marked a 9% increase in charges, an 18.8% increase in collections, a 2.5% increase in expenses, a 4% decrease in accounts receivable, and a 1% increase in visits.

A Group Focus
Timothy P. Schier, vice president of Cain Brothers, investment bankers in Houston, has been involved in numerous hospital and physician group transactions during the past 10 years. He credits successful hospital-affiliated practices with having a group focus rather than an individual or entrepreneurial focus.

Michael Guthrie, MD, MBA, executive vice president of Premier Inc., a health care alliance in San Diego, concurs with Schier. A group’s objectives in a successful medical practice must supersede the objectives of the individual members, he says. A “covenant” exists with respect to the role of the physician in terms of both the practice of medicine and the commitment to the business of medicine, he adds.

A common thread among successful medical groups, he says, is the active involvement of physicians in governance matters, as well as the involvement of physician leaders who can inspire colleagues to achieve the objectives of the group and the affiliated organization.--Edited by Paula Grant, in Lincoln, Va.

Right Strategy, Poor Execution
Hospitals had the right strategy in purchasing physician practices in the 1990s, but they executed the strategy poorly. In fact, some statistics show that more than 90% of hospital-owned physician practices have reported a financial loss.

Hospitals sought to acquire physician practices largely because they wanted to increase inpatient and outpatient business and build managed care networks. Initially, operating practices efficiently did not seem to be a major concern, partly because many hospital executives believed the increased business the practices would bring to the hospital would far outweigh operational losses. But physician practices focus on caring for patients, increasing managed care business, offering more ancillary services (often in competition with hospitals); and (under full-risk capitation) keeping patients out of hospitals. Therefore, physicians trying to make a profit would not necessarily be sending more patients to their affiliated hospitals.

It is now apparent that physician practices that fail under the leadership of hospitals do so for the following reasons:
• Lack of physician involvement in governance and management
• Physician compensation that is not aligned with hospital objectives
• Excessive practice acquisition prices
• Inexperienced physician practice management
• High fixed costs (for information technology, for example)
• A physician focus on primary care versus a hospital focus on other kinds of care
• Overly aggressive valuation.

The valuation of medical practices is generally based on the current assets of a practice or the discounted net present value of the practice. Under the asset-valuation method, the major assets of the practice are valued at fair market prices. Under the discounted net present value method, the purchaser projects the excess cash flow over five years and discounts that figure to the net present value today. Now, it is clear that aggressive valuations did not set an accurate value of a 40-year management agreement, nor did they take into account the difficulties associated with physician recruitment, changes in managed care contracts, or the rising cost of care for an aging population.