Doctors Invest : Hospital Profits Healthy

When Dr. Richard Ayres joined forces with 26 other physicians in 1971 to create Fountain Valley Regional Hospital, all he wanted was “a more comfortable hospital to practice in . . . with a white picket fence.”

The doctor-owned hospital may have been homey enough, but it wasn’t an overnight success. The new facility went broke its first year, Ayres said. It had to borrow money from the Bank of America to pay the nurses’ salaries.

Over the years, however, Fountain Valley Regional has burgeoned from a 113-bed community hospital on 5 acres to a 287-bed regional medical center flanked by gleaming medical office towers on 52 acres.

The physician partnership that owns the institution grew to 85 members, and it no longer has to borrow money to stay in business. According to one industry insider, for many years the hospital has generated dividends to its owners of $1 million a month.

Dividends Suspended

Ayres, now vice chairman of the hospital, acknowledged that the hospital steadily paid dividends until two months ago, when distributions were temporarily suspended to help finance new program costs.

“I made a good deal of money,” Ayres said. “More than I ever expected.”

Fountain Valley Regional is one of a small number of doctor-owned hospitals in Orange County that have developed into major medical centers with consistently high occupancy rates.

Less than a decade ago, doctor-owned hospitals appeared in danger of extinction as large, publicly held hospital chains gobbled up independent facilities in an effort to achieve economies of scale.

Today, these hospitals are openly envied by other institutions that believe they possess an important key to financial viability in an era of cutthroat competition: an ongoing link with doctors who can provide a steady stream of patient admissions.

As a result, nonprofit and chain-owned hospitals are selling ownership interests to physicians and promoting joint ventures with doctors. Existing doctor-owned facilities are expanding their membership rosters and peddling shares to physicians and medical groups.

The impetus for these alliances comes from both institutions and physicians.

Hospitals believe that doctors will probably send more of their patients to facilities where they have a financial stake. Doctors are attracted by the monetary rewards as well as the ability to exert greater influence on hospital policy making.

Among the more recent developments:

Two groups of physicians at San Clemente General Hospital are vying to acquire control of the hospital from American Healthcare Management, a Dallas-based hospital chain currently in bankruptcy reorganization.

A physician group at Chapman General Hospital in Orange expects to enter into a joint venture with American Healthcare Management in which it would purchase 45% of the hospital’s real estate and 100% of a company that would operate the hospital.

Friendly Hills Medical Group, a partnership of 94 doctors, last spring bought La Habra Community Hospital, a money-losing, 299-bed hospital previously owned by Health Corporation of America, for $25 million.

Republic Corp., another Dallas-based hospital chain, is looking for a doctors group to buy an ownership interest in Coastal Communities Hospital in Santa Ana.

Mission Hospital, Midwood Community Hospital and Fountain Valley Regional--all currently owned by physician partnerships--are making additional ownership shares available to doctors on their medical staffs or at nearby competing hospitals.

Some government and industry observers fear that joint ventures tend to promote excessive use of hospital and medical services because doctors have a financial incentive to make referrals, thus increasing costs incurred by Medicare and private insurance carriers.

They also argue that doctor ownership of hospitals and ancillary services such as clinical diagnostic and X-ray laboratories limits competition among such services, which otherwise would be obliged to appeal to physicians on the basis of quality and price.

Dr. Tom Mayer, a consultant with Mercer Meidinger Hansen in Los Angeles, criticizes the swing toward doctor-owned hospitals and the proliferation of doctor-owned outpatient services.

“This kind of structure creates the potential for auctioning off your patients to the highest bidder,” Mayer said.

Dr. Frederic Jansen, 60-year-old chief of staff at St. Joseph Hospital in Orange, said he clings to the old-fashioned belief that it is unethical for doctors to own hospitals because it might make it difficult for them to practice medicine objectively.

“If you owned a piece of the action and the venture was going into bankruptcy you might feel pressured to support it by sending patients there,” he said.

Others, like Orange County Medical Assn. President Dr. Russell Ewing, say they see nothing inherently wrong with doctors owning hospitals or other medical businesses.

“For many years, major hospitals were started and run by doctors, including Scripps Clinic and Mayo Clinic,” Ewing said. “Up until the 1960s, doctors were traditionally the administrators of hospitals. It makes fine philosophical sense because doctors know more than anyone else what a patient needs.”

There are some safeguards against abuses. The federal Medicare Medicaid Anti-Fraud and Abuse Statute, known as the “kickback statute,” prohibits physicians from receiving any remuneration in exchange for patient referrals.

In 1986, the California Legislature enacted a law requiring physicians to disclose to patients if they or their family members have an ownership interest of either 5% or $5,000 in services for which their patients are billed.

New regulations to clarify what kind of doctor joint ventures are within the law are being drafted by the Office of Inspector General of the U.S. Department of Health and Human Services.

Legislation that would forbid providers of Medicare services to accept patient referrals from physician investors has been proposed by U.S. Rep. Pete Stark (D-Oakland), chairman of the House Ways and Means subcommittee on health. The bill applies to doctor-owned outpatient medical services only, not hospitals.

Financial Records

Despite the concerns, organizers of doctor-owned hospitals in Orange County are attracted by the bright financial records of such facilities as Fountain Valley Regional Hospital and Mission Hospital Regional Medical Center.

According to Richard O’Neill, a south county developer who joined a group of doctors to found Mission, doctors who made individual investments of about $20,000 now are reaping dividends of about that amount annually.

Moreover, O’Neill said, a share in the hospital that sold for $20,000 or less in 1969 is worth about $200,000 today.

George McLay, who was employed for 12 years as administrator at Mission, said the hospital partnership was making a before-tax profit of $12 million annually when he resigned that post two years ago. Of that amount, about 65% was being reinvested in the hospital.

Works as a Consultant

McLay, who now works as a consultant to a doctors group vying to acquire control of San Clemente General, said the San Clemente doctors “would love to be like Mission.”

Doctors at San Clemente and similar institutions complain that large hospital chains are insensitive to local needs and tend to funnel away funds from more profitable hospitals to support less profitable ones in their far-flung systems.

Brian Marsal, chief executive officer for Republic Health Corp. in Dallas, said the company recently established a new hospital in Dallas as a joint venture with staff doctors and has converted another four of its hospitals into joint ventures.

He said the cash flow at each converted hospital has improved substantially because of reductions in operating costs and more efficient capital spending on new equipment. In some instances, he said, money-losing hospitals have been turned into profit-generating institutions in just a few months.

In the next two years, Marsal said, Republic intends to convert most of its 20 hospitals in California, Florida, Texas, Indiana and Georgia into joint ventures. One of the hospitals on the list of prospective candidates is Costa Mesa-based Coastal Communities Hospital.

Hospitals also are counting on joint ventures to bring them an influx of patients.

Not Just Dollars

Stanley Mayberg, a retired physician who has invested in numerous Orange County hospitals, said doctors are not courted simply because they have funds to invest.

“It’s not the dollars,” said Mayberg, who is chairman of Mission Hospital Regional Medical Center and Midwood Community Hospital. “If we were just looking for dollars, we could ask the public to invest. Doctors are still the primary customers of hospitals.”

Chris Wheeler, president of a company that is spearheading doctor joint ventures at Chapman General and San Clemente General, said he expects they will increase the occupancy of those hospitals by 30% and 20%, respectively, because participating physicians would begin diverting their patients from competing hospitals.

Organizers of physician groups at the two facilities say they are designing partnerships that would admit only active members of the hospital staffs. Anyone who retires or leaves the area would be required to sell their shares back to the partnership.

Dennis Long, chief of staff at Chapman General and leader of an effort by physicians to acquire control of the hospital, said the plan is to make hospital shares available only to “primary physicians,” such as internists and family practitioners, who make most patient referrals to hospitals.

He said that the physicians in the proposed Chapman partnership would be expected to work on the hospital’s board and committees.

“What we don’t want is passive investors,” he said. “They (the investing physicians) are going to have to look at this as a responsibility instead of just a source of income.”

As more doctor-owned hospitals are forming, older ones are not resting. They are selling new shares, even at the risk of reducing future profits to current partners.

Reynold Welch, chief executive at Mission Hospital Regional Medical Center, said only nine of the approximately 70 physician partners in the center are active members of the hospital’s medical staff. Other staff physicians at Mission want to join the partnership, Welch said.

So to help finance a new $45-million hospital expansion program and to appease its staff doctors, Mission is selling stock to new physician investors.

The hospital is also forming limited partnerships with local doctors to develop outpatient surgery and diagnostic imaging centers.

Mayberg, Mission’s chairman, contends that if the hospital did not organize doctors itself, entrepreneurs would create physician joint ventures that would compete with the hospital.

Not all doctor-owned hospitals are wild financial successes. Midwood Community Hospital in Stanton, which was purchased in a 1979 foreclosure sale and refurbished by a group of physicians, is struggling in a geographic area that is rife with competition.

Midwood lost money last year but hopes to break even this year, especially if the hospital succeeds in selling additional partnership shares to referring physicians.

Other physician-owned hospitals, such as Placentia-Linda Community Hospital in Placentia, sold out to chains several years ago partly because they were unable to raise sufficient capital to refurbish and keep up with the competition.

Undermining the effectiveness of physician group ownership as a financial safety net for hospitals is the growing popularity of health maintenance organizations, which decide what hospitals will provide treatment for patients.

Pushing Ahead

Nonetheless, organizers of new doctor partnerships are pushing ahead. At San Clemente General, McGee said he is putting in five-hour meetings each week with other doctors trying to overcome obstacles to their planned co-ownership of the hospital.

McGee said he wants to help create a first-rate hospital in which to practice. But he also wouldn’t mind a monetary return on investment.

“I’ve put a hell of a lot of time in this,” he said. “I hope there is a reward at the end of the tunnel.”