Is the Independent Hospital Dead?

2:1 January 2023

My last newsletter, which struck a chord with many of you, spoke about loneliness as the next emerging health challenge[1] . As we start the new year, there is a corollary to this at the corporate level embodied in the concept of independence. Similar to being self-sufficient/isolated at the individual level (may contribute to loneliness), remaining independent at the corporate level tends to promote the concept of freedom and autonomy. This gives rise to the enduring concept of the independent hospital, of which there are fewer over time.

Most people who read this article will recognize this is not a new topic. However, as current economic conditions continue to challenge conventional wisdom it is worth taking stock. A recent article in Becker’s noted 19 hospitals that had closed so far last year[2] . We are entering a period of sustained challenges that have already proven too much for some healthcare organizations, especially smaller organizations in smaller markets. Even vulnerability in bigger markets is evident in the dramatic closure of the 460-bed Atlanta Medical Center in downtown Atlanta. Other recent articles have noted the tenuous status of rural healthcare (183 closures since 2005[3] ) and their attempts to weather these tough conditions.[4] Notices also run rampant at the moment of layoffs and cash deficiencies, closing services and related news from both independent hospitals and major health systems. I would love to wax optimistic at the start of a new year, but reality sets in.

Reality is hard to escape. A Christian professor of philosophy at USC some years ago, was asked by a student what “truth” is. His response is worth considering. “Truth is reality,” he said. “And reality is what you bump into when you are wrong.” Are we wrong in our attempt to retain the autonomy of our independent hospital in the midst is such dramatic challenges?

Forgive the length of this discussion, but unpacking this issue involves a number of difficult and emotional factors that we may find ourselves bumping into. Hospitals are among the few institutions (includes churches and schools[5] ) that historically have defined the American community. Many factors can influence the ability of a hospital to remain independent (versus joining a larger health system). No doubt one key factor is critical mass. This is a crucial factor deserving of its own treatment, which I defer to the next newsletter.

Joining a health system today gets tricky as noted by many recent deals that have been called off or unwound[6] . One interesting case study worth noting relates to Hoag Memorial Presbyterian Hospital in Newport Beach, CA that recently decided to regain its independence by leaving Providence Health after being together almost 10 years[7] . In a successful lawsuit filed by Hoag seeking to leave the system, they complained that the affiliation undermined local decision-making and constrained its ability to meet the needs of local patients. (The 52-hospital Providence Health system had previously reported significant operating losses.) Obviously, not every community can boast of the wealth and favorable attributes of Newport Beach, CA.

While tough economic conditions may not be unique to healthcare, the impact could be overweighted in healthcare, as the industry has long been operating with thin margins and is visibly becoming more fragile under sustained economic challenges. In the midst of the arduous task of trying to make sense of complex factors, where do things stand for those healthcare organizations for which remaining independent is highly regarded?

Let’s take a bit of a detour here. What executive would not welcome as much autonomy as possible in fulfilling their responsibilities? It seems clear both intuitively and from experience that more autonomy exists in the C-Suites of independent hospitals than those that are tethered to a larger health system. Yet, a countervailing factor is that more external factors are impinging on the options available to healthcare leaders along a number of fronts, not least of which is payment schemes driven by federal decisions that are increasingly being made out of sight of the actual delivery of care. To say this is frustrating is a vast understatement. Executives increasingly feel the loss of any ability to influence future policy or payment rates for their organizations.[8] I suggest this feeling of helplessness is key among the several factors leading to burnout, accompanied by a dramatic exodus of executives from their current jobs (the subject of a previous newsletter)[9] .

The inability to match revenues to costs will continue to haunt the industry going forward as an increasing percentage of patients have federal insurance (including Obamacare) versus commercial insurance. Flawed public policy continues to plague healthcare. A key example is a continuous refrain that somehow reducing payments to providers is the same as eliminating cost. Reducing payments through federal programs may reduce outlays, but it is different from reducing cost in the system. Such moves simply shift the burden to cover these costs elsewhere and/or it diminishes the ability of the provider to offer the service. Nate Kaufman in his continuing quest to speak truth to the crisis in healthcare finance reminds us constantly that government programs are infamous for paying less than cost. [10] The American Hospital Association estimates that on average government reimburses 84 cents for every $1 spent on the care of their patients.[11]

Much of what hospitals must contend with is considered fixed cost (versus variable). In this context, reduced payments simply result in operating deficits and force the hospital to attempt to make up for the deficit by seeking alternative revenue sources. This “cost shifting,” which has taken on an art form in the past is being reduced today as commercial payors have been cutting their payments as well, resulting in record profits for some insurance companies. Despite this reduction in payments, Kaiser Family Foundation has reviewed 19 studies on the topic and concluded that this cost shifting has resulted in commercial payors paying on average double Medicare rates to hospitals (even higher for outpatient services)[12] .

Reducing full cost in the system involves efficiency gains such as substituting a lower cost delivery modality for an existing one. Obamacare, despite endless representations to the contrary, has been nothing more than income redistribution disguised as healthcare policy. The hidden secret remains that it initially involved 17 new taxes that continue to subsidize the program without being directly identified as doing so (e.g., hidden tax on certain real estate sales). Even the recent “Deficit Reduction Bill” involved a major subsidy to Obamacare. Estimating the genuine cost of Obamacare would challenge any genius intellect. Despite the successes in expanding access, many of the so-called “savings” resulting from Obamacare have done nothing more than render our health “system” more fragile to economic swings. Absent disruptive strategies that significantly shift resources to lower cost delivery alternatives, the nation’s hospitals remain exposed. We are in for a tough run. Oh for a more stable future. Stability offers predictability. Both are in short supply today.

The inverse of independence is dependence. Questioning the sustainability of independence is not meant to imply that consolidating or joining in a system is necessarily a panacea. True enough, under most scenarios such consolidation will give you access to more resources, though not necessarily more capital. The capital issue might qualify as “the big lie” about healthcare mergers. The hospital that wishes to join an established system is now late in the game and can easily be deceived into believing that joining such a regional system will immediately provide greater access to capital.

Based on my experience, the reality is that you will then have the right to get in line; in line with the other hospitals that eat from the same trough. Your projects will simply be added to those of other system facilities with opportunities prioritized throughout the system. The only capital you can count on is a portion of what you generate from operations. Even in this regard, there is likely to be a “corporate tax” that you must integrate into your expenses (usually at least 3-5% of revenues). Does that mean there is no additional access to capital? Not necessarily. But it does place a premium on initial negotiations. To clients seeking access to capital in the short run I always advise that the initial deal that you make when you enter the system is where this is most likely to occur (when you have the most leverage); not what you are likely to gain downstream. I believe this one misunderstanding is responsible for the relatively considerable number of mergers that were called off this past year. I liken the lack of preparation for entering into negotiations to join a health system with golf: most matches are lost before a single shot is made due to lack of preparation and unrealistic expectations.

That said, there are other “in kind” resources that will ultimately determine the success or failure of a hospital merger. This would include access to talent and technology. After these considerations, is the independent hospital as we know it dead? No, but it is not getting any easier to navigate the never-ending array of hurdles that get thrown in the path to success. Government has a unique ability to invent new ways to make business challenging. The CMS decision to reduce the conversion factor used to calculate physician reimbursement for 2023 is only the latest policy action that is devoid of any logic,[13] especially in light of current inflation.

Market factors alone will remain challenging for the near future according to the study Kaufman Hall conducted on behalf of the American Hospital Association[14] . This is especially true in considering the new mandate to address social determinants of health (SDOH), which I fervently support. At the same time we continue to focus on the difficult shift of our core business toward community-based ambulatory care, with less dependence on inpatient services. This is not meant to diminish in any way the importance of inpatient services, but that is not where most of the future growth is. There may be no greater challenge to any business than to adjust its core. It is worth recalling the ill-fated JV attempt by Amazon, Berkshire Hathaway, and Pfizer (Haven) to disrupt healthcare (Amazon continues in this quest through Amazon Clinic). Many similar attempts by many other companies can be cited in the graveyard of healthcare reform.

I have been privileged to work with a number of large and small independent hospitals on their ongoing strategies, and most of them remain independent to this day. Their success has been the result of courageous boards and management teams coming together to embrace disruptive strategies involving their service portfolio, and to invest in infrastructure apart from the historical core of inpatient care. They have recognized the new engine for growth: virtual and ambulatory care which, for most of these organizations (after several years of investment), now constitutes the majority of their revenues. The ability to set aside and designate capital for growth (often through a sober strategic planning process) involves delaying needed upgrades to the traditional business, which is not easy to do. For those organizations that have been able to convene around a shared vision that recognizes the true levers of growth (including adopting some retail strategies), independence can remain a viable option.

But even this success requires further clarification. In focusing on independence, it must be said that this is not the independence of the past, which was based on self-sufficiency. The more contemporary market demands a dose of what I have coined “disruptive collaboration.” This can include a variety of arrangements, sometimes called partial mergers. Under such arrangements, it is the expertise of partners that comes into play for specific service lines (e.g., cancer care, cardiac, behavioral health, and orthopedics). This is not the tired arrangement of “affiliations”[15] but a more permanent connection that combines capital (i.e., joint risk) with talent in ways that are often site neutral[16] . Being site neutral in this context involves sharing in the net proceeds while acknowledging the expenses that relate to the revenues derived at each site (which are different at each site). It is the interdependence of both risk and reward that is key to this formula (not just reward).

Having a desirable location or site (or more accurately sites plural) is vital to independence in and of itself. If you are still relying on the model of “build it and they will come” involving just the existing hospital site, your days are numbered. Your brand (yes it must be managed as a brand) must be amenable to expansion beyond your traditional market (geographic and with other segmentations, such as age, clinical service line). If there is any good news here, it is that CoN laws have been relaxed in some states (e.g., FL) to the point that collaborating with a developer can be timely in funding new facilities dedicated to ambulatory care.[17]

That brings up the last and most crucial factor that will determine success or failure in retaining independent status—your connection to the community. Reduced to a finer point, any service business strives to be that essential resource for their customers. Achieving this requires the ability to manage experiences in such a way that creates loyalty from customers that will then identify your organization as their “partner.” Customers today who are seeking healthcare services have an increasing array of choices, especially digitally. In addition to visible, branded sites, an independent hospital must have a relevant digital presence for key offerings.

In the past I frequently found myself working with voluntary boards that sadly had as their primary mission “to remain independent.” This is a classic case of goal displacement. Remaining independent is not a strategy, it is an outcome. If you are able to remain independent, it will increasingly result from the ability to manage the risks of transforming the business of healthcare. In doing so, you have the proven capacity to provide meaningful experiences that address the needs and wants of the people served where they are (i.e., where they live, work, and shop). Gen Z is about experiences. Healthcare, done right, recognizes this and manages the experience, customized wherever possible.

Remaining independent does not have to be a pipe dream, but it requires clear intent and superior execution. Further, there must be effective distribution (sites), different from the past, with access across multiple platforms. The secret sauce of a successful healthcare organization today (weather independent or part of a system) is to be responsive to loyal customers (existing and future) by consistently meeting or exceeding expectations, providing experiences, wherever possible, tailored to their interests and schedules (convenience). Given the choice, unless the option to join a specific health system offers a proven track record of continuous improvement in staged program experiences, remaining independent (i.e., the status quo) wins.

While retaining independence can remain both a noble and (hopefully) sustainable outcome,[18] there are no guarantees. And the risks seem ever greater as the war of attrition in healthcare continues with fewer hospitals and a more competitive market that willingly embraces new and innovative ambulatory and virtual delivery schemes. Voluntary boards of independent hospitals need to recognize that one of the tangible benefits of being part of a regional system is the well-established career path that some larger health systems can offer your key executives. With so many top executives leaving their current jobs, retaining critical executive talent may be the greatest threat to remaining independent.

[1] You might also be interested in the thorough if disturbing book by Noreen Hertz, The Lonely Century. How to Restore Human Connection in a World That’s Pulling Apart. (New York: Currency, 2021)

[2] Filed bankruptcy, closed, or announced plans to close. 19 hospital closures, bankruptcies in 2022 (beckershospitalreview.com)

[3] 183 rural hospital closures since 2005 (beckershospitalreview.com)

[4] https://www.dhirubhai.net/posts/american-hospital-association_rural-hospitals-in-peril-aha-activity-6991398283600416768-Z9qc?utm_source=share&utm_medium=member_desktop

[5] Look at how much churches and schools are changing

[6] 11 called-off hospital deals (beckershospitalreview.com)

[7] Hoag Memorial leaves Providence. Hoag, Providence to split: 5 things to know (beckershospitalreview.com)

[8] For a more complete discussion see Chapter 3 “The Mounting Challenges of Executive Roles” in my latest book: Executive Turned Consultant (Health Administration Press, 2022).

[9] What Role Will You Play? | LinkedIn

[10] See Nate Kaufman, https://www.dhirubhai.net/posts/nathan-n8-kaufman-07b8a03_healthsystems-healthsystem-healthcare-activity-6997644850401607680-ms-Y?utm_source=share&utm_medium=member_desktop

[11] Fact Sheet: Underpayment by Medicare and Medicaid | AHA

[12] How Much More Than Medicare Do Private Insurers Pay? A Review of the Literature | KFF

[13] Nate Kaufman, “The single dumbest decision in healthcare in the past several decades.” LinkedInhttps://www.dhirubhai.net/posts/nathan-n8-kaufman-07b8a03_healthcare-physicians-healthsystems-activity-6993899034881011712-QNGx?utm_source=share&utm_medium=member_desktop

[14] https://lnkd.in/g2ykch2q

[15] Tends to be defined in overly broad terms with little obligation by either party

[16] Site neutral is not a term I came up with. It refers to a goal of federal reimbursement determined to pay the same for a service, regardless of where the service is offered. This is reversal of historical federal policy that for decades has recognized the cost differentials of offering services in different markets and types of facilities (e.g., hospitals versus freestanding ambulatory care facilities). Implementing global site neutrality, which has been challenged at the policy level by the industry for years, will decimate many programs currently offered in hospitals.

[17] As reported in, “HRE developers see opportunities in 2023--Activity is likely to slow, but 'there's still a need for development” HREI News Update January 4, 2023

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[18] A future newsletter will more thoroughly address the concept of critical mass as it pertains to this topic.