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  • Healthcare Vertical Integration and Internal Audits Role in Strategic Transactions September 2014
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  • Page 2 Agenda I.Healthcare vertical integration II.Internal Audits role in strategic transactions
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  • Page 3 Health industry integration is not black or white Shades of collaboration exist, although the trend is strongly to the right Source: Single MDs; small groups; single hospitals Independent physician associations, single specialty groups, hospital chains Hospital staffs (primary care physicians employed by hospitals), some university/faculty practices Multispecialty group practices (primary care- based practices with full complement of specialty services) Clinically integrated delivery systems (multispecialty groups with hospitals) Clinically and financially integrated systems (multispecialty medical groups integrated with hospitals and health plans) Less integrated or organized systemsMore integrated or organized systems Horizontal Vertical Most ACOs are formed in this space
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  • Page 4 Vertical integration has three primary objectives Payers and health systems are increasingly willing to accept non-traditional risks to preserve their positions in the healthcare supply chain ObjectiveAcquirerTargetBenefitRisk 1. Strengthen revenue streams Health System PhysiciansIncrease referrals and admissions Provider productivity decline post acquisition, inability to influence physician decisions Health System PayerIncrease patient volume and reimbursement rates through a restricted network and reduction in payer margin Financial losses due to under- estimation of member utilization and unit cost PayerHealth SystemCapture enrollment through health system regional presence and brand Acquire disproportionately high-cost members due to health system loyalty 2. Improve control of supply costs PayerHealth System, Physicians Improve ability to manage population health and control medical expense Capital-intensive investment erodes financial viability and flexibility without improving health cost management 3. Defend against disintermediation or exclusion PayerHealth SystemGuard against integrated delivery systems contracting directly with employers or government payers as ACOs Lose network breadth due to reluctance of providers to participate in network of a direct competitor Health System PayerOffset potential exclusion from narrow networks Lose overall managed care volume due to commercial payers unwilling to contract with a direct competitor Health System PhysiciansAvoid disproportionate admissions to competing health systems Physician unwillingness to modify referral or admission practices
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  • Page 5 Integration activity has come in waves Beginning in the 1980s, a surge in managed care growth fueled health industry integration, both horizontal and vertical Element Trends 1980 2000s Observations Payers -Managed care organizations grew membership and implemented cost control techniques -Payers consolidated -Large managed care organizations used their leverage to negotiate lower cost provider contracts Health Systems -Hospital networks, such as HCA, began to expand by acquiring other hospitals -Hospitals began to form managed care networks -Health systems formed health plans -Larger health systems struggled to create economies of scale or reduce cost -Provider-sponsored health plans initially generated large cash flow; however, months/years later struggled with growth and survival Physicians -Physicians tended to operate independently from each other -Hospitals experimented with employing physicians -Physician groups experimented with starting health plans -Care coordination hampered by a lack of communication channels and incentives -Hospital-physician organizations and physician group-owned HMOs disintegrated over time due to poor management and diverging interests Reform -No economic or political forces driving for lowering the cost of care -Expected Clinton-era reforms failed to become a reality -Providers were not externally incentivized to coordinate care. Revenue could still be driven through volume. Reimbursement -Fee for service (FFS) reimbursement was the industry standard -FFS created an environment where providers and payers existed with inherent, opposing interests -Providers were not incentivized to reduce the cost of care
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  • Page 6 Vertical integration failure is common While the benefits of integration are appealing, realization has been a challenge for most organizations 1945: Permanente Health Plan (later named Kaiser) opens to the public, providing both health coverage and access to hospitals 2010 1965 Rise of managed care organizations and new reimbursement methodologies (e.g., DRGs, per diems, case rates, carve outs) 1992: Humana spins off 77 hospitals as Galen Health Care to focus exclusively on insurance 1972: Humana shifts focus from nursing homes to hospitals, eventually acquiring 77 facilities Traditional fee for service dominated the market 1947: Group Health Cooperative opens in Seattle Washington as a PSHP 1980: Geisenger Medical Center starts the Geisenger Health System (a PSHP) 1969: Harvard Community Health Plan opens as a PSHP 2013: Kaiser sells Ohio health plan to Catholic Health Partners (Health Innovations Ohio) 2014: North Shore LIJ opens CareConnect 2014: Piedmont Healthcare and Wellstar Health System start Piedmont Wellstar Plan 2000: Rush University Medical Center sells Anchor HMO to WellPoint 1971: Rush Univ. Medical Center opens Anchor HMO 1980 1995 1998: UPMC launches UPMC Health Plan 1984: Sentara opens Optima HMO Health Plan Passage of the Affordable Care Act 1983: Intermountain Healthcare creates SelectHealth, a non-profit health plan 2002: Piedmont separates from Promina Health, exiting the health plan market 1994: Promina Health founded by Piedmont Healthcare 2012: Sutter Health launches Sutter Health Plus 2001: UniHealth divests its medical and insurance practices 1993: Sutter Health opens Omni Healthcare Plan 1999: Sutter Health sells Omni Healthcare to BCBSCA 1986: HealthWest (later UniHealth) launches CareAmerica 2011: Highmark acquires West Penn Allegheny Health System 2011: Humana acquires 300 clinic Concentra Health 2011: UnitedHealth Group acquires 2,300 physician Monarch Healthcare 1990: Cigna acquires majority ownership of Lovelace Health Systems 2002: Cigna sells Lovelace to Ardent Health Services 1998: AHERF files for bankruptcy 1986: Allegheny Health, Education, and Research Foundation (AHERF) begins integration efforts, purchasing physician organizations and hospitals
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  • Page 7 Strategic, Financial and Operational Risk Vertical integration is fraught with risk Endeavors have failed for myriad reasons, but at the core is typically an under-estimation of the risks to be managed Limiting financial wherewithal by taking on too much at once Inadequate physician alignment, particularly within primary care Paying for productivity gains that do not align with the acquired entitys new incentives Inability to effectively coordinate care across the integrated delivery system Insufficient capability to execute core new functions (e.g., pricing, reserving, practice management) Not clearly defining each entitys role within the system Developing organizational capabilities too far in advance of market demand Optimistic assumptions regarding willingness of business partners to make concessions
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  • Page 8 Element Trends 2010-2014 Observations Payers -Slower membership growth due to escalating premiums -Reduced ability to limit risk through underwriting; forced to manage risk once in house -New regulations and taxes negatively impact profitability -Selective vertical integration through medical group or facility acquisition, or partnerships with health systems -Pressured to effectively manage medical expense -Working towards ACO-like payment methodologies (rewarding quality and care coordination) -Increasing member engagement Health Systems -Renewed focused on acquisition/merger activity to increase scale -Rapid EHR adoption driven by financial and care coordination incentives -Payments increasingly tied to quality metrics -Increasing acceptance of risk through ACOs -Positioning for inclusion in narrow payer networks and alternative contract arrangements -Focused on clinical/operational excellence -Patient demand for price transparency -Technological advancement opening new communication channels for providers and patients Physicians -Rapid movement towards health system employment -Physician group consolidation -Primary care shortage -Broader acceptance of evidence-based medicine, standards of practice and clinical pathways -Improved ability to coordinate care and control costs -Gradual movement towards transparency of outcomes Reform -ACO and patient centered medical home development -Health Insurance Exchanges provide new forum for individual and small group market competition -Increasing public acceptance of cost control techniques (e.g., narrow networks, Medicare Shared Savings Services Program) -Health Insurance Exchanges increasing patient volume will likely challenge primary care capacity -Quality programs are necessary core capabilities -Transparency in quality measurements is increasing consumer driven health care Reimbursement -Value-based reimbursement models -Shared reward systems (e.g., MSSP) -Compliance contingent reimbursement (Meaningful Use, Medicare STARS Program) -Increased provider risk acceptance -Payer and provider incentive alignment -Risk-based payer revenue The next wave is upon us Regulatory and market changes are prompting both defensive and opportunistic integration moves
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