Who Closes Hospitals?

Who Closes Hospitals?

A series of recent hospital closures points to the limits of the U.S. multi-payer healthcare system. Private provision cannot guarantee public access so long as insurance companies fuel rising costs.

Hahnemann University Hospital in July 2019 (Bastiaan Slabbers/NurPhoto via Getty Images)

A facility that saw 53,000 emergency room visits per year disappeared from Philadelphia this summer with the prolonged and still-unfinished closure of Hahnemann University Hospital. The 496-bed hospital employed 2,700 people and saw 17,000 admissions in 2017, its last year under the management of the Tenet Healthcare Corporation. Tenet, one of the nation’s largest for-profit hospital conglomerates, owned ninety-six hospitals and nearly 500 outpatient centers in the United States that year. Not all of them turned a profit. Hahnemann, for example, booked $790 million in revenue in 2017, $115 million short of breaking even. So Tenet embarked on an international restructuring program, liquidating seventeen low-margin hospitals in the United States and the United Kingdom. In Philadelphia, Tenet sold Hahnemann to Joel Freedman, a man from Los Angeles who sat on the advisory board of the University of Southern California’s Leonard D. Schaeffer Center for Health Policy and Economics (his name has since been removed from the center’s website) and managed an investment fund, Paladin Capital, with interests in “the world’s most innovative cyber companies,” according to its website. By spring 2019 Freedman was still losing $3 to $5 million a month on Hahnemann. He had burned through four CEOs in fifteen months. In June, hospital administrators announced that the facility was shutting down.

Hahnemann is just one of the historic hospitals across the United States that has closed this year while claiming that Medicaid and Medicare payments fail to meet rising costs. In November, M Health Fairview, one of the largest healthcare providers in the Minneapolis–St. Paul region, proposed closing the oldest hospital in Minnesota, the 250-bed St. Joseph’s Hospital, after merging with the hospital’s owner, HealthEast, in 2017. In August, both the 200-bed Ohio Valley Medical Center in Wheeling, West Virginia, and the 140-bed East Ohio Regional Hospital in Martins Ferry, Ohio, announced impending closures due to a patient population paying predominately through Medicaid and Medicare. One of the largest rural hospital closures this year was the 400-bed University of Pittsburgh Medical Center Susquehanna Sunbury Hospital in central Pennsylvania. Nineteen rural hospitals closed in 2019, according to the Sheps Center for Health Services Research, the largest number in any year it has recorded.

For hospitals that serve low-income, working-class patients, public insurance payments from Medicaid are the primary source of revenue. Those rates are lower than those of private plans, and hospitals that rely on them often fail to operate as going concerns. If they do, they are often subsidized by the profits of a larger conglomerate.

This problem cuts to the heart of the debate underway within the Democratic Party over how to reform the country’s healthcare system. For presidential candidates such as Pete Buttigieg who insist on retaining the multi-payer system for hospital financing, private insurance represents a positive good to be protected. During an October debate hosted by CNN, for example, Buttigieg objected to the idea, espoused by Senators Elizabeth Warren and Bernie Sanders, that “the only way to deliver affordable coverage to everybody is to obliterate private plans.” Public health insurance, Buttigieg and his supporters argue, pays benefits inadequate to guarantee high-quality care. As Tom Nickels, an executive vice president of the American Hospital Association (AHA), told the New York Times, a single-payer system “would have a devastating effect on hospitals and on the system all over.”

But as the history of Hahnemann Hospital illustrates, it is private insurance that is fueling rising costs among hospital conglomerates in the United States, making Medicare and Medicaid payments appear paltry by comparison.


Socialized Medicine

The provision of medical care in the United States is today nearly everywhere supported by the pooled resources of insurance programs managed from Washington, Wall Street, and state capitols. In 1960, over half of the nation’s healthcare “consumption” (non-investment) spending came directly from the pockets of individuals; by 1980 these direct payments had fallen to less than a quarter of the revenue going to doctors, hospitals, and pharmaceutical companies. Today the portion carried by individuals is about one in nine dollars spent: the overwhelming majority of the industry’s funding now comes from pooled insurance benefits.

Within this gradual socialization of healthcare financing, the share of insurance spending managed by government authorities has grown. Total spending by the Medicare and Medicaid programs has exploded twenty-fold in real terms since the early 1980s. Yet as public spending on healthcare consumption increases, as a share of all insurance spending it has plateaued around 50 percent. As the federal government has attempted to shape and stretch the pools of socialized healthcare financing to extend access—broadening enrollment in public insurance and regulating expenditures of private insurance—it has been continually stymied by the industry’s rising costs. This is part of the reason why, since Congress amended the Social Security Acts to create the Medicaid and Medicare benefit programs in 1965, healthcare spending as a share of total spending in the United States has increased from 5.6 percent of GDP to nearly 18 percent in 2015. As early as 1994, the congressional appropriation for Health and Human Services, the cabinet-level agency that houses both the Social Security Administration and the Center for Medicaid and Medicare Services (CMS), surpassed that of the Department of Defense. During the past thirty years, healthcare spending has come to rival military contracting as the primary channel through which the federal budget interfaces with the national economy. About a third of this spending goes to hospital expenses—more than the portion claimed by either professional practices or pharmaceutical companies.

In the period that healthcare spending has risen vertiginously, the number of hospitals has been declining. Since 1975, according to the AHA’s Census of Hospitals, the absolute number of hospitals in the United States has fallen by nearly a third, from 7,156 facilities to 5,564 facilities in 2015; in the same period the number of beds has fallen from 1.46 million to 900,000. The reason is in part the operation of the profit motive in the multi-payer environment. To maximize returns on patients covered by private insurance, health system managers are continuously pursuing mergers to consolidate employment of highly specialized staff and ownership of costly machinery into fewer high-acuity hospitals (facilities where patients need a higher level of care), reducing price competition in the process. The flipside to this consolidation of high-acuity services is the expansion of the number of clinics and low-acuity services. Hospitals serving populations predominately covered by public benefits are the first to close because their patients represent a lower return.


The Tenets of Consolidation

The history of Hahnemann Hospital’s penultimate owner, Tenet Healthcare, traces the main outlines of the sector’s consolidating ownership. Formed in 1969 by a trio of Beverly Hills attorneys as National Medical Enterprises (NME), the company enjoyed a period of rapid growth during the opening years of the Medicaid and Medicare programs. When the Reagan administration tightened regulations on how hospitals could bill Medicaid and Medicare in 1987, the company had transitioned into psychiatric and elder care. Greater discretion in treatment—and billing—was allowed in these services, and NME shortly became the largest owner of nursing homes in the country and an operator of seventy-four psychiatric hospitals and rehabilitation centers. The expansion came to a halt in the early 1990s, when investigations by Congress, the State of Texas, and a group of state attorneys general discovered the conglomerate had regularly instructed its doctors to refer Medicaid and Medicare recipients to its own facilities and, once there, to alter diagnoses to match patients’ maximum billable insurance categories. In order to exhaust insurance payments, minors brought in for psychological diagnosis or drug addiction had been regularly committed to psychiatric hospitalization for periods ranging from hundreds of days to over a year.

In 1993 the FBI raided the company’s Santa Monica offices and found it had logged doctors’ “productivity” in such referrals and paid them accordingly. “If you fell below the productivity level,” an official with the Department of Justice explained at the time, “you would be cut off from the bribes.” The company sacked two of its founders, promoted one of its bankers to CEO, and sold off all its psychiatric holdings. “They [the Department of Justice] treated us like criminals,” complained David Layne, an executive and associate general counsel at the company, in 1996. “It was a very irritating process for some of us to go through.”

In the wake of the scandal, NME pivoted to the pattern of mergers and acquisitions that brought it to its current height. In 1994, the company owned thirty-five general hospitals. That year it completed a merger with the thirty-seven-hospital American Medical Holdings, changed its name to Tenet Healthcare, and became the second-largest hospital manager in the country. A predictable sequence of purchase and consolidation has persisted ever since: in 1997 Tenet purchased OrNda, then the third-largest for-profit hospital operator, growing to 127 hospitals; the next year it purchased a number of Pennsylvania hospitals, including Hahnemann, as part of the liquidation of Allegheny Health—the largest nonprofit bankruptcy in national history at that time.

Tenet continued to grow until 2002, when the Department of Justice again raided the company and again issued indictments for Medicare fraud. Executives had returned to the practice of compensating doctors for Medicare referrals and regularly overcharging Medicare beneficiaries for “outlier” payments—charges for hospital costs beyond Medicare’s centrally scheduled rates. The company paid a $10 million settlement in 2007 to conclude the government’s investigation into these “outlier” charges. In the same year, in a move representing how central for-profit medicine has become to organized political power in the United States, Tenet appointed Jeb Bush to its board of directors.

When Tenet was not absorbing major competitors, it was trimming its own costs and closing hospitals. The company announced the sale of thirteen hospitals in 2003 and another twenty-seven in 2004. From an absolute high of 130 hospitals in 1999, the company shrank through the sale or closure of its holdings to forty-nine hospitals by 2013, when it purchased the twenty-eight-hospital Vanguard Health and began the cycle anew. In 2017, executives at the company were again charged for fraud, this time for $400 million in illegal billings to the Medicaid programs of the states of Georgia and South Carolina.


Legal Looting

Since 1999, according to the Kaiser Family Foundation and the AHA, the share of all hospitals in the United States managed by for-profit companies such as Tenet has risen from 15 to 25 percent. Medicaid and Medicare fraud by stock-issuing corporations, however, is only the more egregious example of how the healthcare industry is pinching the public’s pocketbooks.

The broader—and legal—strategy for raising hospital revenues is to raise prices. In the face of sustained demand and increasing access to public finance, hospital management consolidation has strengthened hospitals’ ability to determine the prices paid by patients or insurers. The price index for hospital services maintained by CMS’s Office of the Actuary has increased from 24 points in 1980 to 107.5 points in 2017, an increase of 450 percent. By comparison, the Consumer Price Index maintained by the Bureau of Labor Statistics has increased by just around 150 percent in the same period. In other words, the cost of hospital care has increased roughly three times faster than the general rate of inflation in consumer goods since 1980. (The trend is forecasted to continue. In 2018 CMS projected total healthcare spending to rise by 5.5 percent each year for the next eight years, a trend driven both by price increases and by greater service volumes due to the aging population’s shift into Medicare coverage.)

Companies like Tenet that move into urban markets and establish quasi-monopoly power over the pricing of services are at the forefront of this trend. CMS sets the rates it pays through Medicaid and Medicare, and these public benefits, many argue, are too low to cover costs. In response, hospitals, physicians, and pharmaceutical companies argue they must offset lost income from regulated charges with higher bills to private insurers. (The earliest insurance fraud lawsuits against NME came not from Uncle Sam for Medicaid fraud but from Wall Street.) As more and more funds flow through the insurance industry, the cost of private insurance—the yearly difference between premiums collected and benefits paid—has risen from 3.7 percent of all healthcare spending in 1960 to 6.6 percent of a much greater total today. As Dean Baker recently wrote for CNN, “The administrative costs of private insurers are more than 25% of what they pay out in benefits each year. By contrast, the administrative costs of Medicare are less than 3% of what is paid in benefits.”

Because there is hardly a city in the United States with an open market in medical services where the free play of supply and demand could chisel down prices through competition—and it isn’t clear that such a model would even be desirable—hospital rates are inherently monopolistic. Just try negotiating next time you are at the doctor. Medicare and Medicaid rates, moreover, are calculated according to cost information collected from the hospitals themselves. Yet aggregate total hospital margins—the difference between revenues and expenses divided by revenues—have increased from 5.6 percent in 1995 to 7.8 percent in 2016, according to the AHA. As even the Center for American Progress, a centrist Democratic Party think tank, reports in a recent healthcare whitepaper, “An alternative explanation for the gap between public and private [insurance] rates is that hospitals that can demand high prices from private payers enjoy a bigger financial cushion and face less pressure to contain costs, which in turn makes Medicare and Medicaid payments look relatively low by comparison.”


A Fully Public System

For decades, liberals in the United States have framed the central problem of healthcare as how to guarantee public access through private provision. Under the Obama administration, the federal government attempted to compel private insurers to absorb the costs of improving access, both with the stick of regulating their benefit payments and the carrot of the individual mandate that U.S. citizens buy into private pools. But as has been the case since the split-payer experiment began, those empowered to distribute services—hospitals—have had no check on their self-aggrandizing. The result is rising prices, with nearly one in five dollars in the U.S. economy going to the industry.

It’s little wonder the cash cow survives. Hospitals serve as regional power centers for local business elites, who staff their boards of directors, play influential roles in city and state politics, and hire administrators to keep them growing. As the historian Jennifer Klein wrote in 2003, “The managed care revolution of the 1990s reorganized the delivery and financing of health care. . . . But now, for-profit HMOs use the original design of the service plan to restrict medical services, augment executives’ salaries, and divert resources away from patients to stockholders.”

That underlying dynamic has been playing out among nonprofits, too. This September, for example, Sanford Health of Sioux Falls, South Dakota, which operates forty-four hospitals in twenty-six states, announced its intention to merge with UnityPoint Health of Des Moines, Iowa, which operates thirty-two hospitals in three states. If approved by the Federal Trade Commission, the merger would establish the fifteenth-largest nonprofit hospital company in the country. For such tax-exempt organizations, the large margins that come with building such powerful conglomerations aren’t paid out in dividends or stock options but in the form of executive salaries. The heads of organizations such as Kaiser Permanente or Arizona’s Banner Health earn $10 million and $25 million salaries, respectively, compared to the industry norm of $4 to $6 million.

Ironically, the Trump administration’s move to eliminate the individual mandate—a requirement that a federal appeals court ruled on December 18 is unconstitutional—may simplify the problem: the Clinton-era vision of effectively regulating the insurance industry like a public utility appears, over the past decade, to have run up against its political limit. As the private insurance industry shakes off federal regulation and pulls back its coverage, the share of healthcare spending directly administered by government will increase. Profiteering companies will become more dependent on fewer buyers: the share of all healthcare spending financed by federal, state, and local governments is projected to increase from 45 percent to 47 percent by 2026. That means their revenues will fall under public control. Already, Medicaid and Medicare combined make up over half of all health insurance spending in the United States.

The elimination of public-private partnerships in healthcare financing is difficult to imagine. But even with a single-payer system, the reliance on private provision poses certain refractory problems to the adversarial system of government-business relations in the United States. Centralized price controls from Washington will invariably conflict with the private organizations responsible for provision. The United States has foreboding precedents for this problem: both food rationing during the Second World War and oil rationing during the 1970s were met by private industry with informal boycotts and the withholding of product from market. The potential for this dynamic is part of the reason that Aneurin Bevan, architect of the National Health Service in the United Kingdom in the 1940s, insisted that the service include hospitals rather than merely provide national health insurance.

The Democratic Party’s protection of the healthcare marketplace has given the alternative unusually clear expression. In Philadelphia, after Tenet sold Hahnemann in January 2018, the private equity company Paladin immediately restructured the hospital into a series of separate LLCs. One group owned the facilities’ real estate. The other was its hospital-operating tenant. When Paladin lawyers filed for Hahnemann’s bankruptcy in federal court in July, the real estate the hospital occupied—several buildings, including the institution’s hallmark Broad Street building, a stone’s throw from city hall—was conspicuously absent from the Chapter 11 proceedings. Splitting a company so you can lease property to yourself is a practice that originated in leveraged buyouts of legacy retail chains with extensive urban real-estate holdings like Sears and Toys “R” Us. More recently, maximizing land rents has become a fixture of professional expertise among managers of other kinds of city institutions, from school districts to hospital management companies. As the real-estate conglomerate CBRE reports, “Hospital and health system executives face cost pressures.” Luckily, “they control a historically underutilized asset . . . $1 trillion of owned real estate.”

Hahnemann’s real estate was withheld from the hospital’s creditors, including the private equity behemoth Apollo Global Management and CMS, which alleges millions of dollars of questionable federal payments were charged by the new management—a continuation of a pattern in the industry. Most conspicuous of all was the first item on the auction block in bankruptcy court: the right to receive 550 CMS-funded medical residency positions, funding previously committed to the hospital’s academic affiliate, Drexel University. A consortium of the city’s remaining low-income hospitals filed to purchase the federal funding, further consolidating their hold on regional service pricing. Naturally, CMS has objected to the purchase and sale of its medical-education program, and the case is now awaiting a hearing in the Third Circuit.

According to the accounting conglomerate PricewaterhouseCoopers, the projected increase in healthcare spending in the United States “creates opportunity for private equity to grow its footprint in the industry.” Bain & Co.’s annual report on healthcare mergers declares “healthcare’s sturdy fundamentals and track record of strong performance were a beacon for investors seeking a safe haven” amid the uncertainty facing many markets.

For half a century, our hospitals have operated within this halfway house of private control, where charitable public financing meets the self-seeking designs of free enterprise. Whether through higher premiums or payroll taxes, the public has continued to foot the ever-growing bill for healthcare’s delayed passage into public control. When will it be time to complete the transfer?

Andrew Elrod is writing a dissertation on the history of wage and price controls at the University of California, Santa Barbara