Health Firms Go Under the Budget Knife

The black Chevrolet Caprice that ferries American Medical International President Walter L. Weisman to his office in Beverly Hills from his Woodland Hills home is one of the few corporate comforts at AMI since industry cost-cutting forced Weisman to put his health-care company on a stern regimen.

Since last fall, Weisman--who says the car and driver enable him to get more work done during a long commute--has slashed operating budgets by a third, laid off more than 120 employees and pared everything from overnight mail to office space.

Despite the moves, AMI suffered its first-ever quarterly loss--$82 million--for the three months ended in February, 1986.

“Private industry has only begun to scratch the surface” of cost containment, Weisman said. “You think this is bad, you haven’t seen anything yet. . . . A year from now, it will be even tougher in our industry.”

After a decade of robust growth and record profits, the hospital industry has been hit with financial problems. Medicare, Medicaid and private insurance have restricted payments and clamped down on escalating medical fees. Hospital companies are also losing patients to health maintenance organizations and preferred-provider programs, which seek to provide lower-cost health-care services.

Major Chains Hurt

Nowhere is the new climate being felt more strongly than at the major hospital chains such as AMI, National Medical Enterprises, Humana Inc. and Hospital Corp. of America. All four have suffered declines in net income in recent months. Admissions and occupancy rates at the 73,000 beds controlled by the four chains have dropped to all-time lows.

“This has become a tough, competitive environment--no doubt about it,” said Richard K. Eamer, chairman and chief executive of NME.

In response, the companies have pared staff, sold dozens of hospitals and streamlined operations. They also are becoming more aggressive, eyeing new marketing techniques and sophisticated technology to stimulate business and improve efficiency.

The changes are especially evident in Southern California--home of AMI and NME, the nation’s second- and third-largest hospital chains, as well as the headquarters of the nation’s largest investor-owned nursing home chain and health maintenance organization.

The two hospital chains, together with eight smaller publicly held health-care companies in Southern California, had about $10 billion in revenue last year. Altogether, the 10 top California health-care firms employ about a quarter of a million people nationwide.

For all their size, however, the giant chains have captured less than 3% of the $430-billion annual health-care market. And they remain deeply dependent on the federal government’s cost-conscious Medicare program--which furnishes about 40% of hospital revenue--and the equally frugal state Medicaid programs, which contribute about 15% of hospital revenue.

A report by Sanford C. Bernstein & Co., an investment research firm in New York, said stagnating Medicare rates could “force 10% of the (nation’s 5,550) hospitals into bankruptcy” by 1990.

“The financial pressures on hospitals are going to continue,” said Randall Huyser, a health-care analyst at Montgomery Securities in San Francisco. “Hospitals are being hit with a double whammy” of tighter Medicare fees and competitive HMOs. “If we have another freeze on (Medicare rates), hospitals are going to find the financial climate onerous.”

After decades of reimbursing hospitals for their actual costs in treating patients, Medicare began trying to be a tough customer. In April, 1983, a new fee system was approved that pays hospitals fixed rates for 467 specific ailments.

At first hospitals comfortably adjusted to the new rates, which were increased 6.25% in the first few months after the start of the payment program. But trouble began when rate increases slowed.

Congress approved a scant 0.5% increase in May, 1986, and Health and Human Services Secretary Otis R. Bowen has recommended a 0.5% increase for the fiscal year beginning Oct. 1, according to the Health Care Financing Administration.

Meanwhile, states too are holding the line on money for Medicaid--the health-care program for the poor.

Last month, for instance, Gov. George Deukmejian, vowing to retain a $1-billion reserve in the state budget, vetoed about $40 million in increases for California’s $2.3-billion Medi-Cal program. Most of the money would have been matched by federal dollars.

Should Be Grateful

Despite the cutbacks, Secretary Bowen suggested in a statement released with his recommendation that hospitals should be grateful for the small 0.5% increase in Medicare rates since “our findings show that a net decrease would be justified.”

But the beleaguered hospital industry--with its high capital and labor costs--has had a tough time coping with the austerity measures.

Last Wednesday, the nation’s largest health-care chain, Nashville, Tenn.-based Hospital Corp. of America, reported that its net income for the second quarter ended June 30, 1986, declined to $68.9 million from $92.6 million for the same quarter a year ago. The company said the drop occurred partly because its 1986 earnings were being compared to the second quarter of 1985 when the company reported a $45-million pretax gain ($26 million after taxes) from the exchange of 3.5 million shares of HCA’s investment in Beverly Enterprises.

AMI also reported sharply lower profits. Although the hospital chain posted record revenue of $907.5 million, its net income declined 59% to $21.5 million for the three months ended May 31, 1986, compared to $52.6 million in fiscal 1985.

And Los Angeles-based NME said last month that it would sell nine hospitals and undergo a major restructuring in order to improve its sagging bottom line. NME officials said the company, which incurred writeoffs and charges of about $53 million, could post its first quarterly loss ever from continuing operations.

Even Humana Inc., a Louisville, Ky. hospital chain that has had a reputation as being the most profitable and efficiently run, reported that net income in the three months ended May 31, declined to $52.7 million from $58 million during the same period a year ago.

Everyone Affected

“Everyone’s been affected by cost containment,” said Maurice Lewitt, chairman of Nu-Med Inc., an Encino-based hospital chain that operates 15 U.S. hospitals and two acute-care facilities in England. “All the companies are taking writeoffs and adjusting balance sheets.”

For a time, hospitals and other health-care providers were able to keep their heads above water by sending patients home a few days earlier, cutting labor costs and delaying big capital equipment purchases.

“Hospitals didn’t do too badly under the first two years of (new Medicare price controls) and the reason was they were able to respond to the financial incentives by managing patients better,” said Robert Pattison, vice president of finance and economics at the Hospital Council of Northern California.

But more recently, hospitals are discovering that some of the measures they are taking to stay afloat may be exacerbating their plight.

Some hospitals have been trying to offset government cost-cutting by increasing rates for the shrinking pool of privately insured patients whose policies pay for the full cost of medical care. But that approach has forced up insurance premiums and deductibles for the privately insured and prompted many of them to defect to less-costly HMO and preferred-provider plans which directly compete with hospitals.

Costly Readmissions

Similarly, discharging patients early to contain costs has on occasion resulted in costly readmissions. Though Medicare has encouraged early discharges because it is less costly for a patient to recover at home, patients in weaker physical condition are more likely to encounter complications that require additional hospitalization, health-care experts say.

These predicaments have made hospital management a daunting task for administrators.

Other capital-intensive service industries have been able to achieve significant cost savings by lobbying for government deregulation, computerizing many aspects of their operations and building more energy-efficient plants and equipment.

Hotels, for example, operate mostly with low or unskilled blue-collar workers, which helps hold down wages. They have built more energy-efficient hotel rooms and have computerized many administrative functions, such as billings and reservations that used to require scores of white collar workers.

Hospitals also are beginning to experiment with new technology and better management after years of operating outside the arena of traditional supply-and-demand market forces. But progress has been slow.

Ron Bernier, president of Health Care Systems International, a New Haven, Conn.-based firm that sells computer software designed to help hospitals manage their Medicare paper work. He said his firm’s annual sales have risen to about $7 million in 1985 from $1 million in 1983. But he notes that interest in computers is still less than other fields.

“Hospitals have not used computers and new management systems to the extent of other industries,” Bernier said. “The banking industries and financial services industries spend about 10% of their revenues on data processing equipment and software; the equivalent (figure) in the hospital industry is less than 3%” of revenue, Bernier said.

Computer Saved Millions

A new multimillion-dollar AMI computer system that keeps track of patient medical records and hospital bills at the Medical Center of North Hollywood is credited with saving millions of dollars and paring more than 70 people from the hospital payroll.

AMI President Weisman said the health-care company plans to install the computer system in all of its 96 U.S. hospitals.

Hospitals have also used techniques such as imposing productivity standards on physicians, nurses and technicians. The nutritional staff at the Medical Center, for example, is required to serve meals within a given period of time and nurses must work faster when making rounds of patients on their floor, said Katherine Winters, director of nursing.

Most importantly, however, for-profit hospitals have turned to more aggressive marketing as a way to generate new profits.

To lure expectant mothers to its maternity ward, NME’s Garfield Medical Center in Monterey Park offers champagne and lobster dinners to parents who choose the hospital for their delivery. The hospital also advertises on radio and in newspapers and holds an annual health fair at which it offers free and low-cost tests to community residents. More importantly, the hospital is expanding services in areas that are more financially lucrative and reducing reliance on unprofitable services.

In June the hospital knocked down the walls of its little-utilized medical surgery unit in order to open a large physical rehabilitation section. Physical rehabilitation is not yet fully covered by the new Medicare payment system and is therefore more profitable than medical procedures subject to federal cost containment.

The new approach, however, is unlikely to slow the tremendous growth of HMOs and the preferred-provider organizations. Called PPOs, they seek to cut medical insurance bills by giving members a choice of using certain doctors and hospitals (medical providers) who will offer services at reduced rates.

There were more than 300 PPOs in 1985 with about 5 million members, compared to just 68 PPOs in 1980, according to the American Medical Care & Review Assn. Likewise, HMOs had more than 21 million members in 1985, up from 16.7 million in 1984.

Insulate Themselves

In part, HMOs and PPOs achieve cost savings by insulating themselves from the immense capital and labor costs that saddle hospitals. In effect, they lease hospital services by contracting with hospitals and agreeing to supply hospitals with a steady source of patients in return for discounted medical services. Hospitals, desperate to fill their vacant beds, have little choice but to acquiesce to their main competitors.

Roger W. Wessels, executive director of NME’s Garfield Medical Center in Monterey Park, says he now spends nearly half of his time reviewing contract proposals from operators of HMOs and PPOs. In the first quarter of 1986, the hospital held contracts with 30 PPOs and 10 HMOs, about 10 times the number six years ago.

“They are our competition,” Wessels acknowledged. But, he added, “we need their patients” and the revenue they generate.

Though HMOs and PPOs seem to be benefiting from the financial hardship hospitals are currently undergoing, some experts expect the belt-tightening will eventually spread even to the lower-cost health-care providers.

“I think you’re going to see HMOs and PPOs under the same kind of economic pressures that hospitals are under” because of a dramatic increase in competition in that health-care sector, said Jeff C. Goldsmith, a senior consulting adviser to the Ernst & Whinney accounting firm, whose 1981 book “Can Hospitals Survive?” predicted the current hard times in the hospital industry.

Yet some hospital chains, such as AMI and Humana, are diversifying into the HMO and PPO business as a way to cushion the impact of industry cost-cutting. Still, Goldsmith believes the health-care plans offer no salvation.

“That’s like jumping from the frying pan into the fire,” he said. “I think NME has a better chance succeeding with their strategy” of concentrating in nursing homes and other industries not completely subject to cost controls.

Even so, said Goldsmith, “the outlook is going to be grim for most health-care providers.”

FO