Hospital Firm Shows It’s Not Afraid of Risks : Health care: Community Psychiatric Centers is making money by accommodating the current cost-cutting climate. Some analysts foresee a shakeout in the industry.


Community Psychiatric Centers shook the psychiatric hospital industry several weeks ago when it launched a radical new pricing system that will in effect push patients out the doors of its clinics as quickly as possible.

CPC’s marketing strategy marks a drastic departure for the industry. Instead of billing patients the customary daily rate, the firm is offering a flat rate for each case. In so doing, the Laguna Hills company takes the risk of absorbing any extra charges should a patient be hospitalized longer than expected or need to be readmitted. CPC has been doing a lot of risk-taking lately. Last week, the company made an unsolicited $1.1-billion bid to acquire the country’s largest psychiatric hospital organization, Charter Medical Corp. of Macon, Ga. Charter has so far rebuffed the offer.

CPC’s acquisition of Charter, if it succeeds, as well as the new payment system could help reshape the nation’s $5-billion private psychiatric hospital industry, now in a state of severe stress.

The operators of the nation’s 450 private hospitals are struggling to fill beds as they watch the market for their services shrink in response to efforts by the medical insurance industry to rein in runaway medical costs by diverting patients from hospitals to outpatient services.

More important, psychiatric hospitals are having to appeal to a new clientele--the so-called “utilization review” and “managed health-care” companies that employers and insurance carriers have hired to act as brokers between patients and health-care providers. These companies--which are playing an increasingly important role in determining the treatments that patients receive--have become popular with employers looking for ways to clamp down on unnecessary medical treatment and cut down on soaring medical benefits costs.


Some health care officials consider CPC’s buyout attempt the beginning of an industry shakeout that only the most efficient psychiatric hospital firms will survive.

“The psychiatric and substance abuse business is extremely precarious now except for a few very well-managed companies like CPC,” said David Langness, spokesman for the Southern California Hospital Council. “There is a major shakeout occurring in the industry.”

Analysts say CPC’s ability to control operating costs has produced the largest profit margins in the industry. The company, which earned $83 million on revenue of $381.1 million for the fiscal year ended last Nov. 30, has been able to thrive with relatively low occupancy rates at its hospitals because those hospitals were financed with company earnings rather than with debt.

Moreover, CPC’s hospital rates are among the industry’s lowest, a big draw for insurance carriers and their new efficiency experts.

Charter, by contrast, faces severe financial problems and an uncertain future, analysts say, because it failed to respond quickly enough to changes in the industry.

In 1988, when cost-conscious insurance companies and employers were putting a squeeze on industry profits, Charter’s management led a leveraged buyout of the company that left it shouldering a $1.7-billion debt. Charter lost $311 million for fiscal year 1990 and $46.5 million for the most recent quarter. Charter missed a debt interest payment last month. It has proposed a debt restructuring program that would give bondholders and holders of preferred stock a 73% stake in the company.

In addition to the debt burden, analysts say, the company also is laboring under excessive corporate overhead, a costly media advertising program and relatively high hospital rates that have resulted in charter losing business to less pricey competitors.

Insurance carriers and employers have good reason to worry about the cost of mental health treatment. A national survey by A. Foster Higgins, a New York-based medical benefits consulting firm, found that mental health costs increased 18% for all employers in 1989 and rose a whopping 47% at companies with 5,000 or more workers.

Many employers looking for a quick remedy are slashing psychiatric benefits. According to a Bureau of Labor Statistics study, 77% of the nation’s employers in 1989 were imposing more restrictive conditions on hospitalization for mental illness and chemical dependency than on other medical insurance benefits; in 1980, 44% were doing so.

Increasingly, employees with mental illnesses or drug or alcohol problems who once would have checked into hospitals are instead being treated at lower-cost clinics.

Hospitals, in fact, are becoming the treatment location of last resort. At the urging of the insurance industry, patients are now being admitted only to treat severe mental health crises or drug withdrawal. Additional therapy is provided on an outpatient basis.

Psychiatric hospitals have responded by creating “partial hospitalization” programs that allow patients to be treated at a hospital during the day and to return home in the evening.

It was a case of bad timing that the demand for psychiatric hospitals began to shrink just after the industry completed a huge expansion of facilities. Many operators had expected an explosion of business after states began mandating employee mental health benefits. The industry had also hoped to benefit from a growing public awareness of mental health and drug abuse problems and a lessening of the stigma attached to psychiatric treatment.

During the 1980s, a flood of new providers rushed into the market and existing chains went on a construction binge. The expansion gained further momentum when several states, California among them, removed regulations that had prohibited new psychiatric hospitals from being built where there were already sufficient facilities.

According to the National Institute of Mental Health, the number of private psychiatric beds in the United States more than doubled between 1980 and 1988, from 17,157 to 42,615.

General hospitals got into the act too, converting empty blocks of medical and surgical beds into psychiatric wings in hopes of boosting their income. Between 1980 and 1988, the number of beds in general hospitals’ psychiatric units grew from 29,384 to 48,493.

The industry is now “wildly over-bedded,” said Richard Kunnes, chief operating officer for U.S. Behavioral Health of Emeryville, a managed-care provider specializing in psychiatry.

“I think you are just seeing the beginning of a deluge of managed care that will shut down a lot of these facilities,” he predicted.

Facilities that specialize in treating alcoholism and drug addiction are being hurt worst by the oversupply.

Ken Estes, spokesman for the National Assn. of Addiction Treatment Providers, said about 50 addiction treatment facilities have closed nationwide in the last two years and patient occupancy rates are “running at 50% to 60% on the average nationally and lower in some metropolitan areas.”

Psychiatric hospitals are having to work harder to keep their beds full because patients are being admitted for shorter stays. According to the National Assn. of Private Psychiatric Hospitals, the average stay for patients in psychiatric hospitals dropped from 30.5 days in 1987 to 27 days in 1989. The steepest decline was for teen-age patients, whose average stay shrank from 43.8 days to 35 days.

The impact of all this on patients is a matter of considerable dispute in the medical community. Critics complain that patients are being shortchanged in the name of cost savings, and advocates argue that it is often more effective to treat the mentally ill in less institutional surroundings.

“In the name of cost-cutting, what they are doing is service-cutting,” said Dr. Peter Gruenberg, president of the Southern California Psychiatric Assn. “There is no question that people are being discharged from hospitals before they are ready.”

But Dr. Alan Sazitz, a Los Angeles psychiatrist, said he welcomes the pressure being placed on psychiatric hospitals to intensify therapy. Sazitz said he has seen too many Instances of patients in psychiatric hospitals spending time watching television.

“I think in the long run the patients will get better care because the care will be monitored and the providers will be selected,” Sazitz said.

Another result is that companies such as Charter that depended on extensive TV advertising to attract patients are finding that this method is not working as well.

“Television advertising was very effective starting in the mid-'70s and worked probably very well until the mid-'80s. But with the growing use of managed care and HMOs, people don’t have the choice of where they will go,” said Estes of the National Assn. of Addiction Treatment Providers.

Chris Jorgensen, who has helped create TV marketing programs for the Comprehensive Care Corp. chain of drug and alcohol addiction treatment centers, credits advertising for “helping to defuse some of the stigma and denial” associated with alcoholism and mental illness.

But Kunnes of U.S. Behavioral Health contends that Charter’s TV ads not only swelled the company’s operating costs but also “tarnished the company with the image of hucksterism by trying to circumvent the physician community.”

James W. Conte, CPC co-founder and chairman, said he considers TV ads inappropriate for a medical company. “We still don’t believe in advertising to the ill: ‘Come, have your breakdown with us,’ ” he said wryly. Instead, CPC hospitals get patient referrals in the community through ties made with local clergy, police departments, schools, family counselors and medical professionals.

Mac Crawford, Charter executive vice president for operations, said Charter has changed its marketing tactics in the last year by slashing its TV ad budget, soliciting more referrals from physicians and trying to increase business with HMOs and other managed-care organizations.

“I think the demand for alternative treatment settings will continue to escalate,” Crawford said, “and we have to be more creative to address the demands of payers and payees and put people in the least restrictive environment that is medically appropriate to them.”

To meet those demands, Crawford said that Charter has developed partial hospitalization programs and established a separate group headed by a former executive in the managed-care industry to deal with the new gatekeepers of mental health care.

He also said Charter has reduced its staff to streamline its work force but that the company intends to maintain a higher staff-to-patient ratio than CPC does to ensure quality.

Peter Sterman, a western regional director for Preferred Health Care Ltd., a national managed-care company based in Wilton, Conn., said that CPC has been able to do well by “cutting corners” on staffing.

“CPC has done wonders financially in this market today when everyone else is having problems. But we have some concerns how they are able to do this,” Sterman said. “Often if there is a Charter hospital and CPC hospital in the same geographic location, my clinical case managers would tend to have a preference for using the Charter hospital because of the higher staff-to-patient ratios.”

But other industry observers see no problems with the quality of care at CPC facilities. Much of the company’s savings, they said, are the result of its keeping a bare-bones administrative and marketing staff.

The key to CPC’s future, analysts say, will be its ability to accommodate the cost-cutting priorities of the managed-care specialists in the insurance industry.

“CPC has been the first out of the chute in terms of approaching managed-care companies and insurance carriers in offering new products like partial hospitalization and innovative pricing,” said Kunnes of U.S. Behavioral Health.

“We decided to work with managed-care companies instead of opposing them,” Conte said. “In effect we are saying to the whole insurance industry that we are willing to talk with them about any reasonable form of payment for a reasonable type of care.”

About four months ago, CPC hired industry veteran John Randazzo to establish a managed-care division for CPC.

Randazzo said CPC realized that its patient referrals from managed-care companies had risen rapidly, accounting for 22% of CPC revenue in 1990, from 12% in 1988.

He said managed-care firms are impressed by the fact that CPC’s average daily rate is $500, below the industry average of about $600, and that the average length of treatment at a CPC facility is 21 days, compared to the industrywide average of about 25.

Randazzo also said that CPC is the first psychiatric hospital company to offer health care management organizations a “case rate” plan for psychiatric and substance-abuse patients.

CPC’s flat-rate payment plan is similar to the system that the federal government has established for Medicare recipients. That system, in effect since the early 1980s, has forced general hospitals to contain costs.

But CPC is not waiting to be pushed. “We are trying to eliminate the adversarial relationship hospitals have had historically with managed-care companies,” Randazzo said.

CPC’s bid for Charter is another part of its strategy to generate more business with managed care-companies and employee groups. CPC hospitals nationwide are only about 50% occupied. By adding Charter’s 88 psychiatric hospitals to CPC’s 50, CPC, which operates primarily in the West, hopes to expand its services nationwide. Steve Powers, president of Cronus Partners, a private investment bank that helped CPC put together the buyout offer, said that both Charter and CPC “are providers of the absolutely highest-quality care. The difference is Community is a low-cost provider and Charter is a higher-cost provider. And the future belongs to the low-cost provider.”

INTENSE COMPETITION IN AN INDUSTRY UNDER STRESS Community Psychiatric Corp. of Laguna Hills has made an unsolicited $1.1-billion bid for the nation’s largest private psychiatric hospital chain, Charter Medical Corp. One of the few financially healthy chains, CPC hopes to emerge from an industrywide shakeout as the No. 1 provider of inpatient mental health care. COMMUNITY PSYCHIATRIC CENTERS Headquarters: Laguna Hills Chairman and chief executive: James W. Conte. Operations: 50 psychiatric hospitals Employees: 6,374 Revenue: $331 million Earnings: $83 million CHARTER MEDICAL CORP. Headquarters: Macon, Ga. Chairman: William A. Fickling Jr. Operations: 88 psychiatric hospitals and 12 acute-care hospitals Employees: 13,700 employees Revenue: $1.28 billion Earnings: $357.7-million loss AVERAGE LENGTH OF STAY In days, for all inpatients 1987: 30.5% 1988: 29.1% 1989: 27% Source: National Assoc. of Private Psychiatric Hospitals GROWTH OF PSYCHIATRIC BEDS Private Psychiatric Hospitals 1980: 17,157 1982: 19,011 1984: 21,474 1986: 30,201 1988: 42,615* * Latest figures available General Hospitals with Separate Psychiatric Units 1980: 29,384 1982: 36,525 1984: 46,045 1986: 45,808 1988: 48,493* * Latest figures available Source: National Institute of Mental Health.