Health Care With a Bottom Line : HealthWest Demonstrates Blurring of Nonprofit and For-Profit Hospitals

Like their counterparts at other successful enterprises, HealthWest executives are proud of their outfit’s bottom line, rapid growth and reputation. They compete aggressively for business, and bonuses for some are linked to earnings.

The only difference is, HealthWest isn’t a company. It’s a tax-exempt, nonprofit health care organization that officials of Northridge Hospital Medical Center said they formed to help the hospital survive and prosper.

Yet HealthWest has tried awfully hard to make money--and its exertions continue even though the future of Northridge Hospital seems secure.

HealthWest is a prime example of how nonprofit hospitals turn into chains and then grow to resemble for-profit health care companies. As such, it illustrates some of the dramatic changes occurring in the increasingly competitive American health care industry.

Not a New Idea

Nonprofit chains aren’t new. In California, religious groups such as Lutherans and secular organizations like Kaiser have run chains for years. But what’s new is the aggressive diversification of newer chains like HealthWest, regarded as an exemplar of the phenomenon even though it’s not one of the biggest.

HealthWest President Paul Teslow says he can focus on medical care instead of profits because his Chatsworth-based organization, officially called HealthWest Foundation, is free of shareholder pressures.

But that hasn’t kept HealthWest from the ardent pursuit of profits and growth. Indeed, with 7,000 employees and $355 million in annual revenue, it has grown far beyond the San Fernando Valley and, in fact, beyond California.

The foundation now owns eight hospitals, and Northridge Hospital has accounted for little more than one-third of total revenue. HealthWest also has formed a wide array of other health-related businesses, including a for-profit health maintenance organization, programs for the elderly and the homebound, and management consulting.

It even started an advertising agency that specializes in promoting medical services. The agency also helps HealthWest manage its roughly $2.5-million ad budget.

For all of their imaginative diversifying, nonprofit hospital chains don’t always have much to show for their efforts.

“Hospital systems have generally not generated profits from their so-called for-profit activities,” said Jeffrey Goldsmith, a health care specialist with the Ernst & Whinney accounting firm in Chicago.

HealthWest, for instance, earned $25 million in the year ended June 30, 1985. Yet the two institutions that were its nucleus when HealthWest was formed in 1979--Northridge Hospital and Valley Hospital Medical Center in Van Nuys--together earned $27.7 million.

In other words, HealthWest lost $2.7 million on everything else.

Audited figures aren’t available for the year just ended, but Teslow said earnings fell to about $18 million.

Ross Goldberg, vice president for communications, blamed start-up costs from the new health maintenance organization, plus an ongoing decline in hospital stays nationwide. But, he said, Long Beach Community Hospital, a HealthWest facility acquired in 1984, generated $2.5 million in surpluses for the year ended June 30.

Strategies Criticized

The strategies employed by nonprofit institutions these days have their critics. Dr. Arnold Relman, editor of the New England Journal of Medicine, said outfits like HealthWest are fine as long as their earnings go for better care, serving the indigent and offsetting money-losing enterprises such as education.

But he questioned whether that is always the case.

“You have to ask yourself: why is HealthWest or any other not-for-profit so anxious to expand its revenue?” he said. “Are they doing it just to gratify their own edifice complex, pay their managers more and grow more powerful? Or are they using their revenues to expand their services to the community?”

HealthWest insists it uses its money to provide better health care, and its hospitals seem well-regarded.

“Northridge and Long Beach have superb reputations,” said Dr. Richard Corlin, a past president of the Los Angeles County Medical Assn.

By at least one gauge, HealthWest appears to be relatively generous in its care for the poor. Nonprofit hospitals in Los Angeles County incurred an average of 3.8% of their patient expenses in the first quarter of 1986 in caring for indigents and others who didn’t pay their bills, according to the California Hospital Assn., a trade group. The five HealthWest hospitals in the county averaged 4.5%.

HealthWest’s growth can be viewed as the outcome of measures taken by governments and insurers to curb rising medical costs.

These third-party payers have increasingly adopted fixed reimbursement schedules rather than looser cost-plus schemes. They also press for fewer, and shorter, hospital stays. The result is that many hospitals are finding it harder to raise capital to rebuild facilities, buy equipment and care for the indigent.

The capital shortages, in turn, have led many nonprofits to merge or start profit-oriented subsidiaries.

“The not-for-profits have been dragged screaming and squalling into the new world,” said Harry Schwartz, a medical economist in New York. The line between for-profit and nonprofit health care is getting so blurred that Keith Deisenroth, a health care consultant with Arthur Young in Los Angeles, says: “I like to differentiate them as tax-exempt versus taxable.”

In 1984, the latest year for which data is available, there were 219 nonprofit hospital systems like HealthWest in the United States, 118 of them religiously affiliated.

Together, these chains owned 1,002 hospitals, up from 472 in 1970--and in those days, there were more hospitals and more hospital beds nationwide. Nonprofit chains today operate another 209 hospitals under contract, so they manage one in five of the nation’s 1.3-million hospital beds.

Actively Diversifying

These nonprofit chains are not just in the hospital business. Like their profit-seeking brethren, they form HMOs, insurance companies and outpatient units, which they say are needed to assure patients for their hospitals and income to care for them properly.

HealthWest’s Teslow “is the most entrepreneurial and aggressive exponent of this approach,” said one knowledgeable consultant.

In some cases, the new subsidiaries aren’t even in health care. A hospital with under-used laundry facilities, for example, might start a contract laundry service. HealthWest even owns a restaurant. Nor is geography a barrier; HealthWest has a hospital in Bellingham, Wash., and is buying another in Secaucus, N.J.

Teslow says that survival for hospitals like Northridge means forming a “health care continuum” offering services outside the hospital as well, since hospitalization is on the wane. He said HealthWest was formed when 345-bed Northridge Hospital found itself having to compete with a number of hospital chains in the Valley.

“We realized we lacked the critical mass to take on the marketplace conditions that were confronting us,” he said, adding that the hospital’s trustees were determined to stay independent and nonprofit.

Teslow Is Spearhead

A 51-year-old Midwesterner, Teslow is the driving force behind HealthWest, an organization that has a net worth of about $135 million.

He isn’t resting on his laurels. HealthWest is committing $40 million over three years to its CareAmerica HMO, started in January, and plans to expand it beyond California. HealthWest’s ElderMed program operates in California, Illinois, Washington, New Jersey and Pennsylvania. It gives the elderly what it calls a “health care coordinator” who arranges doctor visits, handles Medicare paper work and provides other services.

HealthWest also has built a 97-unit senior citizens project in Van Nuys, and has opened a London office to pursue European acquisitions. The foundation has since changed course, Goldberg said, and plans to close that office in October.

Like investor-owned companies, HealthWest fights for market share. At Northridge Hospital, for example, it is adding a unit with 125 beds, making it one of the few hospitals in Los Angeles adding beds rather than just replacing existing facilities.

It also is striving to assure its hospitals and physicians a flow of patients besides those from CareAmerica and ElderMed. It is connected to a big, statewide preferred provider organization, in which doctors agree to fixed costs in return for referrals.

HealthWest’s acquisition efforts include a recent agreement to buy Riverside Hospital in Secaucus, N.J., for $25 million. Just minutes west of New York City, Riverside is the last for-profit hospital in New Jersey. HealthWest plans to make the 200-bed facility nonprofit and use it as a wedge to penetrate the growing suburban New Jersey marketplace.

With assets on June 30 of about $260 million, HealthWest doesn’t seem short of money. The foundation’s estimated revenue of $355 million for the fiscal year ended June 30 was up 17% from the previous year.

Bonuses Instituted

Like many for-profit firms, HealthWest recently adopted performance incentives to reward hospital administrators for higher surpluses. Teslow said the bonuses are needed to keep good executives, but he wouldn’t disclose details of the system or his own compensation.

Kenneth Abramowitz, an industry analyst at the New York securities firm of Sanford C. Bernstein & Co., said such bonus plans are rare among nonprofit institutions now, but won’t be for long, and he praised the idea.

“They manage themselves internally as if they were for-profit,” he said approvingly. “They’re one of the best-managed of the nonprofits.”

But incentive compensation raises eyebrows with critics who find the rationale for all this growth and profit-making dubious. Some prominent critics say nonprofit chains are built more on ego than on need, and those who know HealthWest also say Northridge Hospital didn’t need the support of a health care conglomerate to survive as a nonprofit institution.

“Northridge would have never ended up in investor-owned hands,” said Steve Valentine, a vice president with the consulting firm of Amherst Associates in Los Angeles.

Other critics say Teslow is wandering too far afield. “If he confined his attention to the Southern California area, he’d really be dangerous,” said an industry source.

But defenders respond that all hospitals, even nonprofits, must make money to stay afloat, and that, if their managers think branching out will work, that’s fine.

“In the future,” Abramowitz said, “there’s going to be for-profit hospitals and bankrupt hospitals.”

HEALTHWEST AT A GLANCE

A Chatsworth-based nonprofit health care foundation, HealthWest owns Northridge Hospital and seven other hospitals. It also has a variety of other enterprises, including a health maintenance organization named CareAmerica and an advertising agency.

Year ended June 30, In millions

1986 1985 1984 Revenue $355 $304.2 $240.6 Earnings 18* 25.0 22.3

assets: $260 million net worth: $135 million

employees: 7,000

* HealthWest’s estimate