Physician Practice Strategy: The Private Equity Play
October 20, 2022
Written by Clinton Flume, CVA, Cordell J. Mack, Tim Spadaro, CFA, CPA/ABV, Christopher Tracanna, Colin McDermott, CFA, CPA/ABV
The following article was published by VMG Health’s Physician Practice Affinity Group
Cardiovascular disease ranks as the leading cause of death in the United States, so it should come as no surprise that healthcare executives are placing an increasing emphasis on the stability and growth of cardiovascular services. In addition to the aging U.S. population, management is being forced to take strategic action due to industry factors such as shifting physician employment trends, patient procedures transitioning to lower-cost outpatient care settings, and payor models changing from fee-for-service to value-based care. To ensure continuity of alignment for cardiology providers and stakeholders, executives need to consider the strategic impact of cardiovascular medical group affiliations in their decisions. These decisions include investment in comprehensive cardiac care services, external affiliation models (joint ventures or joint operating agreements), and alignment models with private equity.
According to the Physician Advocacy Institute, as of January 2022 approximately 67.3% of cardiologists were employed by hospitals or health systems, 17.9% were employed by other corporate entities, and the remaining 14.8% were in independent practices. The combined hospital/health system and corporate entity employment (85.2%) was 12.2% higher than the number of cardiologists (73.0%) employed by these entities in January 2019 . Due to the high concentration of employment for cardiology, this specialty has been insulated from the traditional roll-up activity seen in the orthopedic, gastroenterology, and ophthalmology spaces. This suggests the industry is primed for a reversal of employment back to private practice as providers look for ways to diversify from legacy employment models and engage in outside investment opportunities, such as private practices and surgical centers.
Health systems, payors, providers, and, most importantly, patients are increasingly seeking high-quality and lower-cost options for routine cardiovascular care. Outpatient cardiology services began to see a transition to the outpatient setting in 2016 when the Centers for Medicare and Medicaid Services (CMS) approved pacemaker implants for the ambulatory surgery center (ASC) covered procedure list (CPL) . In the 2019 Final Rule, CMS added 17 cardiac catheterization procedures to the ASC CPL, and in the 2020 Final Rule, CMS allowed physicians to begin performing six additional minimally invasive procedures (percutaneous coronary interventions) in ASCs. Additionally, several states have followed CMS’ lead by removing barriers to accessing cardiovascular care in ASCs . The continued approval of procedures to the CPL and expanded access to care are major catalysts for the shift in cardiology services to the outpatient setting and the desire of providers to engage in external clinical investment opportunities.
Cardiologists have long sought refuge from rising costs and downward reimbursement pressure by aligning with larger entities that have more leverage and pricing power. This often materialized through traditional health system employment with many hospital providers looking to operate traditional in-office ancillaries in an adjunct hospital outpatient department. The arbitrage in reimbursement (HOPD versus freestanding) was an offset to the ever-increasing physician compensation inflation. However, challenges continue to mount.
The Medicare Physician Fee Schedule (MPFS) conversion factor has fallen year-over-year since CY 2020. On November 1, 2022, CMS released the 2023 MPFS which continued to lower the conversion factor and resulted in cardiology reimbursement falling an estimated 1.0% . During the same period, many health systems are reporting larger net professional losses per cardiologist as costs continue to rise faster than revenue.
These factors, coupled with bundled pricing initiatives and trends focused on value-based care initiatives, are compelling cardiologists to consider all alternative employment scenarios in response to slowing compensation growth. Whether cardiologists continue to be employed by health systems and corporate entities or they venture into private settings to explore outside investment opportunities, there is no doubt cardiology will continue to face financial pressure from rising operating costs in tandem with reimbursement cuts.
Cardiology employment trends, increasing access to outpatient cardiology services, and changes in payor models are all leading indicators that impact the strategic alignment of cardiology medical groups. The following are key external and internal drivers that serve as signals of the fragmentation of the cardiology market. Healthcare executives should be proactive in their evaluation of these market factors which can dictate how cardiology coverage is delivered and can impact current and future affiliations.
Degree to which cardiology services are provided by independent cardiologists, employed providers, or a group professional services agreement.
High Impact – To determine the top-line revenue impact between two parties’ contracts.
The presence of forward-thinking medical leadership.
High Impact – Visionary leadership required to change the market status quo, and generally visionary leaders see today’s disruption (rate pressure, ambulatory migration, etc.) as opportunity.
Degree to which current employed or contracted cardiology economics remains financially viable.
High Impact – Health system alignment can result in inflated market compensation and greater economic burdens for healthcare organizations. The higher the degree of financial unsustainability, the higher the likelihood of stakeholders (health systems, payors, and providers) are open to alternative structures.
Degree to which physicians are subject to a noncompete or other similar provisions.
Medium Impact – This may delay fragmentation, but ultimately a large cadre of cardiologists seeking an alternative care model will likely prevail.
Depth of managed care and commercial contract consolidation.
Medium Impact – The more consolidated the managed care community is in a market, the stronger the likelihood of evolving lower total-cost care models.
Upon evaluation of the internal and external environment, health systems have strategic options that range from staying the course with minimal change through employment to proactively migrating the cardiology care delivery model in partnership with a private equity-backed platform. Below are strategic opportunities for organizations to consider when developing long-term cardiovascular medical group affiliations.
As healthcare executives evaluate the overall strategic positioning of cardiovascular services, industry factors such as physician employment trends, a shift to lower-cost outpatient care, and changing payor models will continue to change the cardiovascular landscape. Mindful executives with a strong pulse on external and internal factors, such as physician alignment and service line stability, will have an advantage in tactical decision-making. Position opportunities, such as investment in comprehensive cardiac institutes, joint ventures with MSOs, and partnerships with private equity firms, are all potential models for long-term strategic success.
By: Madi Whyde, Savanna Ganyard, CFA, Jordan Tussy, and Madison Higgins
VMG Health reviewed the earnings calls of publicly traded healthcare operators that reported earnings for the third quarter that ended on September 30, 2022. By focusing on the major players in select subsectors defined below, we analyzed the frequency of certain keywords including inflation, COVID-19, interest rates, premium labor, and others. We used these keywords to identify which topics commanded the room this earnings season. Highlights from the calls are summarized in this article.
Volume: Although volume trends are unique to each industry sector nearly all operators remained focused on the impacts of COVID.
Poll: Did the earnings call mention COVID-19?
On a same-facility basis, admission volumes declined as much as 5.0% from the comparable prior year quarter (Q3 2021) for acute care hospital operators. Despite the weakening of COVID-19, the decline in volumes was attributed to higher-than-average cancellation rates (THC), the migration of certain procedures to outpatient status (CYH and HCA), and capacity constraints (HCA). Inpatient volumes generally remained at or below pre-pandemic levels.
Ambulatory surgery center (ASC) operators reaped the benefits of the migration to the outpatient setting and reported positive volume trends when compared to Q3 2021. Surgical volumes were reported as consistent with 2019 pre-pandemic levels (THC), and one operator claimed the business did not experience any material direct impact related to COVID-19 during Q3 2022 (SGRY).
The post-acute sector reported mixed results in volume trends. One operator reported a year-over-year decline of 14.0% in hospice admissions, citing capacity constraints and reduced referrals from acute care hospitals (EHAB). However, another operator indicated that increases in admissions in the second half of the third quarter showed growth that they “haven’t experienced since the start of the pandemic” (CHE).
Volume trends among other industry players including dialysis providers, risk-bearing organizations, and physician services were also affected by COVID-19 in Q3 2022. Headwinds in dialysis volumes are expected to persist for the foreseeable future (DVA), and inpatient volumes for risk-bearing organizations remain below pre-pandemic levels (AGL). Notably, AGL also reported a rebound in physician office visits and outpatient volumes were in line with pre-pandemic levels.
Reimbursement: Declining COVID-19 volumes mean less incremental government revenue for certain industry players who also now contend with an uncertain inflationary environment.
Poll: Did the earnings call mention inflation?
Declining COVID-19 volumes resulted in lower acuity patients and reduced incremental government reimbursement. This softened the reimbursement per admission for the acute care hospital segment. Further exacerbated by inflation, these dynamics were evident in reported EBITDA margins which declined as much as 17.0% (CYH) over Q3 2021. In response, some acute care hospital operators are turning to commercial payor negotiations. Rate increases for the next year are anticipated to range from a minimum of 3.0% (THC) to upwards of 6.0% (CYH).
The post-acute sector did not release specific figures regarding contract rate hikes. However, the sector is optimistically looking for high single-digit rate increases (SEM) to provide relief in the current inflationary environment.
Labor: Unsurprisingly, management teams across the sector were faced with questions about labor trends and management techniques during their earnings calls. Contract labor remained pivotal for the operations of some, but premium labor appears to have softened during the quarter.
Poll: Did the earnings call mention premium or contract labor?
The reliance on contract labor continued its downward trend in Q3 helping moderate expenses. HCA even indicated overall labor costs were stable due to targeted market adjustments. However, contract labor and premium pay remain at uncomfortably high levels for most acute care hospital operators. UHS revealed during their call it will be unlikely to reach pre-pandemic levels in the near future.
Staffing challenges persisted among the post-acute operators and directly impacted volume by as much as 60.0% (AMED). Increased indirect labor costs including orientation, training, and sign-on bonuses were the leading drivers of decreased EBITDA (AMED). Wage inflation, particularly for nursing positions, is expected to rise as much as 5.0% next year (SEM). However, several management teams are optimistic wages will stabilize to historical levels (SEM, EHC) in the near future.
Other industry players, including dialysis and physical therapy providers, also faced challenges with contract labor during the quarter. USPH reported labor costs were approximately 200 basis points higher than Q3 2021 levels, and DVA indicated such costs showed no improvement.
Go Forward Expectations and Guidance: Considering the quarter’s performance, the companies we reviewed were divided relatively evenly in terms of revised FY 2022 revenue guidance, (i.e., raised, lowered, unchanged). In general, the quarter brought about a more pessimistic view of FY 2022 EBITDA, and the majority of public companies lowered their guidance for the year. Further, most stakeholders were left with no guidance for FY 2023.
Poll: Did the earnings call mention a recession?
FY 2022 revenue and EBITDA guidance among the acute care hospital operators was generally left unchanged except for THC which lowered EBITDA guidance. However, all companies that were reviewed declined to provide FY 2023 guidance during the call, and primarily cited economic uncertainty (HCA).
The post-acute sector appeared nearly unanimous in the outlook for the rest of 2022, and most operators lowered their revenue and EBITDA guidance. Unsurprisingly, no one offered FY 2023 guidance during the earnings calls.
Interestingly, risk-bearing organizations mostly raised their revenue guidance for FY 2022 (AGL, CMAX, PRVA). However, EBITDA guidance was less predictable and was lowered (AGL, TOI), raised (PRVA), and unchanged (CMAX).
Most other healthcare operators followed similar patterns in terms of providing guidance for FY 2023. Of the companies we reviewed, only DVA revealed an outlook for the next year. The company anticipates revenue to be flat (driven by unfavorable volume trends) and margins to continue to feel the impact of labor market pressures.
By: Anthony Domanico, CVA and Nicole Montanaro
The following article was published by the American Association of Provider Compensation Professionals
While the healthcare industry has been moving from volume to value for the last two decades, the movement toward true value-based care has really taken off within the last few years. This is because the way health systems are paid has been largely based on fee-for-service payments with a relatively small share of a health system’s revenue being driven through “value.”
The 2022 MGMA Practice Operations Survey found that health systems see approximately $31,000 in value-based revenue per FTE physician . While that figure is just a small portion of what organizations bring in for the typical physician, the expectation among leaders in the healthcare provider and the payor industries is this trend of shifting revenue away from fee-for service and towards value-based care is going to grow significantly over the next several years. As the way organizations are reimbursed moves towards quality and other non-productivity-based metrics, how those organizations pay their physicians needs to evolve in similar ways. Many organizations we work with at VMG Health are engaging our firm in the following ways:
The remainder of this article will focus on common ways organizations are implementing value into their physician compensation plans. It will also include guidance to organizations on how to select meaningful value-based metrics to provide the most value to the organization.
For those organizations just starting on this journey from volume to value, the most important decision is how to start including quality in plans that have previously paid physicians solely based on the volume of their work. Organizations often start by adding a modest amount of compensation tied to value, and typically it is an amount that guarantees a physician’s base salary or rate per wRVU does not need to decrease to make room for the quality incentive while staying within budgetary expectations.
For example, a productivity model at $55 per wRVU with an expected 2.5% budget increase in 2023 might leave the conversion factor at $55 and add a 2.5% quality incentive as a bonus. Over time, that percentage tied to quality can increase as physicians become more familiar with and trusting of value-based metric reports as they are with wRVU reports. However, this process generally starts small and typically tops out somewhere in the 10-20% range for organizations on the value-based side of the volume-to-value continuum.
Once the magnitude of compensation is determined, there are a few main ways organizations typically structure value-based incentives in their physician compensation plans. These structures are typically based on how the organization’s leadership team answers the following question:
Question: “Should quality be the same for everyone, or should there be some variability for factors like productivity, tenure, base salary differences, or other factors?”
These organizations typically pay all physicians the same flat dollar amount, regardless of physician subspecialty area. As an example, every physician, whether a neurosurgeon or a family practitioner, would have the same $20,000 quality opportunity.
These organizations typically use a percent of market (usually median) approach that pays everyone within the same specialty the same total dollars for quality. As an example, every family medicine doctor would receive up to $13,500 (~5% of median), and every neurosurgeon would receive $37,500 (~5% of median).
These organizations typically use a percentage of-base salary approach where the base salary is set according to organizational policies. This might provide a differentiated level of base compensation for factors like tenure, experience, productivity level, or other factors, and each physician can receive 5% of their individualized base salary as a quality bonus. As an example, Family Medicine Physician A with a $230,000 base salary is eligible for an incentive of up to $11,500, and Family Medicine Physician B with a $250,000 base salary can earn up to $12,500.
These organizations typically use either a quality rate per wRVU or a percentage of total production-based comp approach. Under a pure productivity-based plan, if the compensation plan targets a compensation per wRVU rate of $50 then$47.50 per wRVU might be earmarked for wRVU productivity, and an additional $2.50 per wRVU is set aside, and paid based on quality performance. This type of incentive provides different (and sometimes significantly different) quality incentive opportunities for physicians with different levels of productivity.
Regardless of which of these quality compensation structures is selected, when considering supporting quality bonus payments to physicians a key factor is having a substantive set of quality metrics.
VMG Health collected industry research and identified multiple healthcare articles, publications, and other sources related to quality bonuses paid to physicians. The takeaways about value driver considerations related to the metrics are summarized below. While this list is not exhaustive, it does provide the most common and important factors that support quality bonus payments to physicians.
Generally, factors such as paying for the achievement of “superior” performance standards and selecting patient clinical quality metrics demonstrably impacted by the subject physician(s) help to justify higher-quality bonus payments.
Further, the following chart outlines some best practices to consider for identifying and selecting meaningful metrics, as well as factors to consider before including value-based incentives in a compensation model.
It is important to note the considerations described herein are most pertinent when a party wishes to fund its own value-based compensation program. Alternatively, and subject to certain facts and circumstances, if the funding for a value-based compensation program were to be tied to incremental quality or savings payments from a governmental or commercial payor, other factors may be relevant to consider. Some examples of factors are the incremental revenue/actual savings generated, and the risk and responsibility of the parties.
Organizations that are already far along on the value-based care continuum with a robust quality department/program are starting to expand beyond the quality incentive programs outlined above. These groups are starting to include patient access or acuity-adjusted panel size factors to further focus their compensation plans on population health management. Patient access can include incentives for things like open panels, time to third-next-available appointments, or other factors that get layered on top of productivity and quality compensation.
Acuity-adjusted panel size is an alternative productivity metric to wRVUs that attempts to measure how large a panel of patients a particular physician is charged with caring for. Raw panels (actual number of patients) are adjusted for some level of patient acuity factor – an age and sex adjustment factor, hierarchical condition categories (HCCs), or a multitude of other factors to ensure panel comparability. Unfortunately, there is no perfect acuity-adjustment factor, which makes comparing panel sizes to the external market a unique challenge.
Finally, some organizations are using incentives embedded in payor contracts – quality incentives, shared savings, and other payments – as additional incentives in the provider compensation formula. Typically, organizations take some percentage of dollars received from payors to cover costs incurred by the system and to provide some level of additional remuneration to physicians.
As these value-based programs continue to evolve, organizations have many levers to provide competitive levels of compensation to their physicians. These options help move physicians’ focus from being solely on production to providing high-quality care to patients and reducing unnecessary procedures.
With this complexity, however, organizations must be more diligent than ever to ensure their provider compensation programs continue to align with federal fraud and abuse laws. These regulations are also changing and providing additional levels of protection to organizations that ask physicians to take on meaningful downside risk in their compensation plans. Therefore, careful consideration should be taken in establishing a compensation strategy to ensure the compensation levels remain both competitive and compliant.
Written by Clinton Flume, CVA, Tim Spadaro, CFA, CPA/ABV, Olivia Chambers, and Blake Toppins
The following article was published by Becker’s Hospital Review.
The physician medical group sector remains a hot transaction space that outperforms expectations each quarter. This sector’s strong prospects are driven by interest from private equity groups, health systems, and value-based care organizations. However, before buyers operate in this robust sector, they must consider the unique transaction intricacies of such deals, including physician alignment, compensation structure, and due diligence considerations.
For more in-depth insight on this sector, refer to VMG Health’s 2022 Healthcare M&A Report which describes the nature of this sector and summarizes the robust transaction environment experienced in 2021. This report also projected the ongoing elevated deal activity in 2022 which has been confirmed by the 170 deals in Q3 2022 alone (representing a 63.0% increase over Q3 2021).1
Below are three key considerations when executing a physician medical group deal.
Effective medical group alignment strategies are imperative to a healthcare organization’s growth, and the two most common strategies are direct employment and equity investment. The latter can be accomplished through joint ventures or investment in a management service organization (MSO). MSOs are an increasingly popular alignment strategy in states that adopt the corporate practice of medicine (CPOM) doctrine. For more information on MSOs and how they work, read “Physician Practice Strategy: The Private Equity Play.”
According to the Physician Advocacy Institute, 74% of physicians are employed by hospitals or corporate healthcare entities (a 19% increase since 2019).2 The main drivers of this trend include physicians’ financial security, physicians’ professional and work-life balance, the payor environment’s evolution from fee-for-service to value-based care, and the administrative complexities of running a business. In many instances, a direct employment model enables physicians to receive market compensation consistent with their productivity and to focus more closely on clinical initiatives which alleviates their day-to-day administrative responsibilities. From a buyer’s perspective, direct employment models mitigate the risks associated with provider contractual arrangements and enable more definitive long-term planning.
Joint venture structures with physicians may also constitute an attractive proposition for alignment. A joint venture opportunity may take the form of an equity investment in a medical practice (state specific based on CPOM) or in a physician-aligned business, such as an ambulatory surgery center or retail healthcare business. Joint venture affiliations can strengthen physician alignment through synergies such as reimbursement lifts, growth capital, and economies of scale. Along with governance rights, each of these elements plays a key role in defining post-transaction equity alignment structures.
Due to the regulated healthcare industry and strict guidance around physician transactions needing to be consistent with Fair Market Value, it is important that both the business being valued and the compensation offered is documented to be Fair Market Value. Further, there are a myriad of structural nuances that should be considered from a legal, operational, and clinical perspective. As a result, leaning on experts focused on the physician practice sector is highly recommended.
Compensation can be the single most important negotiation item in a medical group transaction. As private equity, insurance companies, and for-profit management organizations enter the sector, compensation models demand careful attention to ensure a good alignment of physician productivity, physician pay, and medical group returns.
External alignment allows providers to benefit from direct investment when shifting to an employment model. Although complex, it has increasingly become the norm for compensation models to factor a physician’s external interests into an agreement.
Compensation arrangements continue to require ongoing innovation to stay competitive and relevant. As transaction activity intensifies and healthcare shifts from a volume-based system of care to a value-based system of care, compensation arrangements must be designed to evolve with the dynamic intricacies of the industry. Understanding the latest compensation models, and how to design those models and a transition plan, has proven to be a critical factor for success with physician practice strategy. For recent insight on design, further information can be found here.
The competitive environment for medical group assets has intensified as capital continues to flow into the sector. As part of the deal process, performing both pre- and post-acquisition due diligence is now the standard for high-value deals. Due diligence focuses on the following areas:
In a unique, complex, and dynamic transaction landscape, expertise in healthcare-specific attributes can transform a transaction. Considering the surge in physician medical group deals as the expected continuing high rate of activity, buyers will have to increase their knowledge of the sector’s intricacies to remain competitive and achieve their strategic goals. At every stage of a transaction, VMG Health’s expertise as the leading provider of healthcare transaction and strategy services provides the advantage needed to execute successful deals.
By: Cordell Mack and Scott Ackman
The following article was published by the American Association of Provider Compensation Professionals.
Organizations are revisiting medical group strategy and physician alignment in the face of private equity investment, growing medical group losses, and a decline in overall performance. Approaches on how to address medical group performance vary but can broadly be categorized as performance optimization (i.e., enhancing the current alignment vehicle) or pursuing a structure change to an existing model that improves sustainability. In lieu of performance-focused optimization, organizations are increasingly considering whether there are alignment models that are more sustainable and functional than traditional employment given the price transparency and site neutrality trends. The following article explores the evaluation of current medical group performance.
More health systems are taking a multi-faceted approach to maximize medical group performance. The exponential growth in physician and advanced practice provider employment and the growth in reimbursement tied to cost, quality, and access have heightened the importance of medical group strategy. However, many organizations continue to experience underperformance across several domains (cost, growth, access, etc.), and attempts to improve performance have stalled or been met with significant resistance. In most cases, the definition of performance is too narrow to identify the actionable strategies necessary for improvement.
Measurement of medical group performance and provider efficiency has historically been based on investment or operating loss per physician. In VMG Health’s experience, questions pertaining to a medical group optimization are complicated and require consideration of several indicators. Commonly used measures like investment per physician and provider FTE are helpful but can be misconstrued without proper context due to a myriad of factors. Some of these factors include but are not limited to medical group provider composition (e.g., primary care, hospital-based, pediatric subspecialties, etc.), medical group structure, care model, payor contracting strategy, overhead allocation, and payor mix.
To truly understand medical group performance, performance should be evaluated across a series of clinical, financial, operating, and community domains to ensure the group’s value is fully realized and understood. Focusing on only one or two aspects of medical group activity can result in an overly narrow and often inaccurate assessment of medical group value. The approach to assessing the economic sustainability/affordability of a medical group should be based on a complete picture of the medical group’s impact on health system financial performance and should not be limited to a simple financial review of practice operations.
It is critically important to consider how the medical group functions, performs, and contributes to the health system in several areas including: 1) growth trajectory and overall affordability, 2) engagement of the provider group, 3) data availability and reporting, 4) provider care model and compensation, and 5) provider governance. Strong performance across one or two domains is not indicative of sustainability and category weighting is required to acknowledge the relative importance of each.
Each of the domains can be evaluated and indexed across several factors to essentially score the medical group’s overall health and determine whether financial, strategic, and clinical alignment requires modification for sustainability.
The affordability domain evaluates the extent to which the magnitude of the hospital or health system’s investment in the medical group is appropriate given the size, operating performance, structure, and breadth. The domain also considers whether the investment is financially sustainable for the organization when tested against the parent organization’s size, operating performance, and market conditions.
VMG uses a wide array of metrics to measure affordability, including but not limited to metrics that measure the enterprise-wide impact of employing physicians. Depending on organizational compliance and internal firewalls related to information sharing, our preference is to develop management models that combine enterprise-wide economic contribution to the underlying net investment in the professional practice.
Without a common understating of enterprise-wide performance, medical groups are all too often in the position of defending their status in a health system. Further, our experience suggests there is increased dissatisfaction among providers and operators.
The degree to which medical group infrastructure and policies support physician-to-physician and physician to group accountability. The engagement domain evaluates whether policies support the individual or the collective, and to what extent the governance structures create peer accountability and a set of medical group values that align with health system goals and objectives.
The ability of the health system and the medical group to track, report (internally and externally), and act on data is essential. Supportive data systems, with actionable dashboards and reports for providers, are deployed to maximize the utility of the group practice. Medical groups lacking effective data tracking, reporting, and management capabilities are extremely limited.
Exponential growth exists in patient care delivery in non-traditional settings and by care teams versus individual providers. What policies, procedures, and models have been developed and implemented that support care innovation, efficiency, and patient access? How well developed are virtual protocols and how mature is the medical group’s thinking about advanced practice provider utilization and deployment? Does this translate into aligned remunerations systems for providers?
The governance domain assesses how decisions pertaining to medical group management and operations are made as well as who is making the decision. There is not a one size fits all approach to organizational structure and decision making. What structures and policies support provider-led management and decision-making? To what degree are service line management and medical group operations integrated to assure efficient and effective operations.
Completing an internal assessment across these domains will benefit the medical group and the broader health system clinical enterprise. Completing this type of assessment generally assumes arrangements are fair market value and commercially reasonable, however, there is some inherent connectedness between affordability and internal compliance standards. Since the inception of the Stark Law in the late 1980s, there have been concerns about the commercial reasonableness of physician practices that lose money. While most operators could rationalize why practice in a health system model may lose money, there have been decades of discomfort with the strict interpretation of the Stark Law. In the most recent changes to Stark, there has been a clarification noting that the determination of an arrangement’s commercial reasonableness does not turn on whether the arrangement is profitable. Under the statute, there are several examples of community need, EMTALA, charity care, and quality that may support underlying commercial reasonableness despite practice losses. Nevertheless, assuring internal compliance policies and oversight are contemporary with the current law is paramount.
In VMG Health’s experience, questioning medical group sustainability is both essential and complicated. Many organizations struggle with assessing current performance in a way that provides a comprehensive view and provides actionable strategies for improvement. It is critical this work effort is organized in the right way since a simple benchmark exercise is largely ineffective in driving change.
As we enter 2022, we look back to reflect on the major trends that shaped the healthcare sector over the past year. COVID-19 continued to be a major player throughout 2021, forcing healthcare systems to adapt to new variants, rising labor pressures, financial activity, and new regulations. Despite these challenges, the sector remains optimistic and ready to adapt.
Here are five key takeaways we believe defined the healthcare sector over the past year:
After the Q2 earnings season, VMG Health released an article analyzing post-COVID healthcare operator guidance. Generally, we found that healthcare operators were optimistic about the recovery of their revenue and adjusted EBITDA metrics over pre-pandemic levels, with most operators increasing their FY 2021 guidance with each subsequent reporting period.
While optimism for recovery to pre-pandemic levels remains, it appears that the post-acute operators have tempered some of their recent growth expectations. Based on disclosures of the public operators, the recent resurgence of COVID-19 through the Omicron variant has caused additional strain on the post-acute sector. During the J.P. Morgan Healthcare Conference, Universal Health Services (“UHS”) CFO, Steve Filton noted that the company was struggling to find providers who can accept COVID patients once they are ready to be discharged from the hospital.
Post-acute providers appear to have been hit especially hard by the recent labor shortages in the healthcare industry (discussed further below). As compared to the hospital operators, the financial performance of these post-acute providers has been affected disproportionally by the labor shortages. While hospital operators have been receiving additional reimbursement for COVID patients, helping to offset a portion of the increased staffing costs, the post-acute care providers have not received a similar subsidy.
Due to these recent pressures, Select Medical Holdings Corporation (“SEM”) released an expected earnings announcement in advance of the actual results, in which it noted “the unpredictable effects of the COVID-19 pandemic, including the duration and extent of disruption on Select Medical’s operations and increases to our labor costs, creates uncertainties about Select Medical’s future operating results and financial condition.”
While we have seen increasing optimism by healthcare providers over the past few quarters, the recent disclosures from the post-acute sector illustrate that the effects of COVID continue to ripple through the healthcare sector. With the fourth quarter results being released over the coming weeks (HCA and Encompass recently released), it will be interesting to hear if other sectors report similar headwinds.
Healthcare labor expenses continued to exceed historical levels with a 12.6% year-over-year increase based on a recent analysis of over 900 hospitals. Labor expenses grew at a faster rate than the number of clinical hours worked, which supports the notion that rising labor costs were not due to increased staffing levels but rather due to labor shortages driving higher pay to improve employee retention. Part of the labor shortage can be credited to the surge of Delta and Omicron variants in the second half of 2021 that resulted in high volumes of quarantined staff and a reliance on costly contract labor and travel nurses. At the Bank of America December 2021 Home Care Conference, LHC Group announced a decrease in quarantined staff throughout Q4 from a high of 4% down to 1% in December. This indicates that the labor market issues will see some improvement as health systems’ dependence on pandemic-related contract labor declines as COVID-19 surges dissipate going into 2022.
A more concerning challenge faced by all sectors was the shrinking workforce, coined the “Great Resignation.” The Bureau of Labor Statistics reported healthcare and social assistance workers had the second highest quit rate in November 2021 at 6.4% due to increasingly high levels of professional burnout. The waning labor force has prompted companies to offer additional incentives such as shift and retention bonuses. For example, HCA reported during Q3 a 10-12% annual increase in FTEs being in the premium pay categories. Many large public players have voiced an anticipation of continued high levels of premium pay, competitive bases, and higher annual wage inflation to attract and maintain adequate staffing levels in 2022.
Leaders in the industry have announced initiatives to decrease labor pressure primarily by focusing on recruiting and retention to bounce back to pre-pandemic levels of employment. With a heightened focus on attracting and maintaining adequate levels of hired staff as opposed to contract labor, it appears the overall industry expectation for 2022 is that labor costs will likely decrease compared to 2021 although not to pre-pandemic levels. The chart below shows the percentage change in employment across the healthcare sector from the Bureau of Labor Statistics Job Openings & Labor Turnover Survey from February 2020 to November 2021. This highlights the steady recovery toward pre-pandemic staffing levels for outpatient care and physician offices, the continued employment challenges in home health and hospital settings, and the notable struggle for community and nursing care facilities to return to a state of normalcy.
Deal activity within the healthcare sector was strong in 2021 with industry-specific multiples that reached or in many cases exceeded 2019 levels. Experiencing a noticeable rebound from 2020, volume and value of deals grew by substantial margins on a year-over-year basis. Deal volume in the health services industry rose by 56% while value rose 227% in the TTM 11/15/21 period. Long-term care led all sectors with the highest volume of deals, as seen historically, and continues to remain a hot spot in the transaction space. Similarly, physician medical groups and the rehabilitation sector experienced the largest growth transaction volumes year-over-year.
Physician medical groups have received vast interest in physician employment from private equity firms, new-age value-based care organizations, services arms of managed care giants (Optum, Neue Health), and health systems. This, coupled with independent physician group operating challenges from COVID-19 related volume impact and looming Centers for Medicare and Medicaid Services (CMS) cuts, is creating a robust transaction environment that is expected to continue during 2022. For the rehabilitation sector, strong demographic tailwind, along with the lifted CON moratorium in Florida and continued joint venture interest between health systems and strong rehabilitation operators (Select, Kindred, Encompass), has resulted in material deal volume in the space.
Hospitals and health systems were the only sector to see a decline in volume of deals, down 26% from the previous year. Despite the decline, the total transaction size of deals only dropped slightly year over year, indicating larger deal-size on a per-transaction basis. The acceleration of megadeals taking place, the shifted focus on scale, and the diversification of their business models all drove average total size per deal higher than seen before in 2021.
Effective January 1, 2021, the Centers for Medicare and Medicaid Services (CMS) implemented a price transparency rule requiring hospitals in the United States to provide accessible pricing information to patients about the cost of the care they may receive. Hospitals must display negotiated rates for all items and services, in a machine-readable format, so that patients can compare prices before arriving at the hospital.
Though, in July 2021, a study was published by PatientsRightsAdvocate.org detailing that a vast majority of hospitals were not compliant with the new rule. At the release of the study, the penalty for non-compliant hospitals was $300 per hospital, per day. While many patients advocate for CMS to stiffen penalties for non-compliant hospitals, healthcare professionals argue against the rule, stating CMS did not provide enough clarity on what the rule should entail.
A vice president of a large U.S. health system discussed the ambiguities around the rule with Fierce Healthcare. “One interpretation is you simply publish your rate schedule – whatever your rate exhibits are in your contracts, publish that and that’s compliant. Another one is to summarize these [CMS] packages [and] what your negotiated charges are.” For many health systems, the resources required to implement their rates in a machine-readable format far outweigh the penalty of remaining non-compliant. The VP stated that he believes many hospitals already provide their rates in a clear, understandable way, but the rule’s lack of clarity and the requirement for a machine-readable format make compliance difficult and costly.
In November 2021, CMS released the 2022 Outpatient Prospective Payment System (OPPS)/Ambulatory Surgery Center (ASC) Payment System final rule (OPPS Final Rule). Within this rule, CMS increased penalties for hospitals that are not compliant with the price transparency rules and removed barriers for patients accessing online pricing information.
While the Final Rule may be beneficial for patients, Stacey Hughes, Executive Vice President for the American Hospital Association (AHA), states that they “are very concerned about the significant increase in penalties for non-compliance with the hospital price transparency rule, particularly in light of the many demands place on hospitals over the past 18 months, including both responding to COVID-19, as well as preparing to implement additional, overlapping price transparency policies.”
The new penalties, visible in the chart above, went into effect on January 1, 2022.
A record number of health and health services companies went public during 2021 by way of SPAC or IPO. Rebecca Springer, a private equity analyst with PitchBook noted, “The multiples in public markets are very, very strong right now, so you can get, all else equal, a better return on your investment if you go public with your company rather than selling it to a strategic investor.”
Unfortunately, while the stock market might be performing well, the recently public healthcare operators have not faired as well since their initial offerings. The Healthy Muse Health Tech Index (“HTI”) generally underperformed the overall performance of the stock market, with the majority of the players finishing in red; the HTI declined 35% as opposed to the 27% gain for the S&P 500 during 2021. The public markets seemed like a perfect place for an exit strategy given the multiples observed in the public markets. All recent entrants finished the year below the original IPO price and while the reasons for the price declines varied it is clear the public markets are less forgiving with valuations if an organization does not achieve expectations.
Overall, the healthcare sector experienced highs and lows during 2021 as it continued to navigate a post-COVID world. As pandemic pressures continue into 2022, healthcare institutions will have to keep a close eye on staffing costs and abide by new regulations. Despite these challenges, the appetite for M&A transactions and market participation in the sector remains strong. We look forward to a new year of challenges, wins, and continued changes in this interesting industry.