Memorial adds up to high-stakes deal for UCH

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University of Colorado Health is counting on its national reputation to turn around Memorial Health System’s finances and recoup its investment in leasing the hospital system.

UCH is pouring cash into Memorial — providing a “blockbuster” deal that includes $5.6 million a year for 30 years after an upfront payment of $259 million, and allows the city to keep its $330 million in cash and investments. The deal additionally promises $3 million a year for 40 years for a branch medical campus and $1.1 billion in capital improvements to Memorial’s properties.

It’s a lot of money. And it’s a big gamble for UCH.

“It’s a risk,” said Steve Berkshire, director of the doctoral program in health administration at Central Michigan University. “They’re gambling on their name and reputation to increase the patient ratio and to improve the market share.”

It’s a risk, he said, because Memorial has a strong competitor that has been chipping away at its market share for years.

“A lot of what happens is going to depend on what Centura does,” he said.

Centura Health is the parent company for Penrose-St. Francis Health Services, a nonprofit hospital with two locations in the Springs. While Memorial has been mired in a two-year discussion about its future, Penrose, through Centura, has been quietly adding partners — including partnerships with Rocky Mountain Children’s Hospital and with the Rocky Mountain Cancer Center. It’s added rural hospitals from around the Western Slope and all the way into Kansas.

During the request-for-proposal process, Penrose President and CEO Margaret Sabin said the hospital was ready to compete with an outsider leasing Memorial. That competition, she said at the time, could lead to a medical arms race, with each hospital trying to compete for patients by buying the latest equipment and technology.

It’s also a gamble because the future of health care itself is still unresolved. The Supreme Court hasn’t yet ruled on the constitutionality of the Affordable Care Act, creating more uncertainty in the industry.

“To go forward with that big question unanswered — that’s a risk,” Berkshire said. “Who knows what health care will be like in 20 years?”

City Attorney Chris Melcher agreed that UCH was taking on a big risk, and deserved its share if it increases Memorial’s profit margins.

“They deserve that money, because who knows what health care is going to look like in 20 years?” Melcher asked. “That’s a risk they’re taking away from us — we don’t have to worry about how it could change.”

Essentially, UCH is creating an accountable care organization, required under the Affordable Care Act. By creating economies of scale, the health care organization could save money at Memorial and improve its bottom line. By providing a network of more than 15,000 health care workers, it also could attract patients from around Southern Colorado.

“Right now, some of those people skip over Memorial and go straight to Denver,” City Councilor Bernie Herpin said at a meeting discussing the lease. “Is there a plan to attract them to come here?”

There certainly is, said Bruce Schroffel, president and CEO of UCH.

“We plan to make this the mothership of Southern Colorado,” he told council. “We plan to expand services to all of El Paso County and to all of Southern Colorado.”

Another risk to UCH and Memorial: uncompensated care. Memorial currently handles the bulk of uncompensated care in the city, to the tune of about $74 million a year. UCH’s charity care obligation is about $300 million; something Schroffel said is “unsustainable.”

“It’s grown about 50 percent in the last few years, and we are looking at ways to mitigate that,” he said. “It’s unsustainable for us, and we, like hospitals around the country, are trying to find ways to change that.”

Not only will UCH inherit Memorial’s uncompensated care, it will inherit a hospital system with a revised lower outlook for the future from Moody’s Investment Services — a system with financial issues surrounding lower patient volumes since the recession started in 2008.

Even as its profit margin remained at a healthy 10 percent for April, higher than budgeted, the hospital’s net income dropped to $328,323 for the month due to unrealized investment losses in the stock market.

“I am concerned,” Schroffel said. “It’s a risk. It’d be disingenuous to say otherwise. The hospital’s had a tough couple of years, and we’re going to stabilize it. Then we’re going to expand services.”

But before Memorial can grow, he said, UCH has to assess its financial health, reassure employees and move the hospital to more stable footing.

UCH has managed to maintain its high-quality care and its profit margins, even during uncertain times. Its profit margin is around 21 percent, but Schroffel said that six years ago it was in much the same position as Memorial today.

UCH also would inherit a hospital where employee morale is low, due in no small part to the uncertainty that has surrounded the system. But all that could change, Berkshire says.

“The city is partnering with a hospital with a great reputation,” he said. “And they could be planning on bringing research and residencies to the Springs; it’s going to bring the medical campus. Employee morale could turn around instantly, once this is all settled.”

The city didn’t get all the benefits from the deal . When UCH takes over, it will assume no debt and no retirement obligations. The deal says that the city will handle paying off bonds and other liabilities, as well as negotiating with the Public Employees’ Retirement Association to exit the program. Being free of those obligations means UCH can expand without pressures of debt payments or answering to bond-holders, Berkshire said.

It’s in both the city’s and UCH’s best interest to build on Memorial, increasing patient volumes and outcomes. The deal gives the city 5 percent of Memorial’s profit margins above the 8 percent it currently averages — and that could mean an additional windfall of as much as $2 million a year in payments to the city.

But the incentive to increase the profit margins could equal higher prices for hospital services.

“That’s what usually happens, nationally, when there’s a takeover like this,” Berkshire said. “Prices go up. They don’t go up immediately, but sometime after the first year, there will be pressure to recoup the initial investment. That’s when prices go up.”

Not so fast, said Schroffel. One reason to create a partnership with three hospitals is to lower costs, not increase them.

“Our prices will be market-driven,” he said. “Just like any hospital. Raising prices is not at all in our plans. We plan to expand services, expand the reach, bring people to the hospital. That’s how we’ll earn money.”

City Councilor Jan Martin echoed his comments, saying that the partnership was about increasing care for Colorado Springs residents.

“If we thought we were doing this deal by taking it out of patients’ pockets, we wouldn’t be doing it,” Martin said. “I don’t believe higher prices are going to be part of this — at all.”

Improving quality of care, using UCH’s quality standards, could also improve Memorial’s bottom line, and could help drive down costs. Focusing on patient volume without raising prices is one way to offset the costs associated with acquiring Memorial, Berkshire said.

“They could bring higher quality, assuming that’s one reason the patient volumes are down,” he said. “That alone could improve the bottom line. And if they bring in more partners — doctors will want to be associated with the prestigious university — that will also bring in more patients. If they have research here, then that all can be seen as affecting prices.”

Schroffel isn’t yet saying which services will be expanded, and which will fall by the wayside. UCH has committed to carrying all current core services for at least three years.

For its part, UCH believes that economies of scale, combined quality practices, increasing the number of paying patients with private insurance, and expanding services beyond Colorado Springs will allow it to recoup its investment.

Despite uncertainty over prices and insurance payors, the city had little choice but to move ahead, Berkshire said.

“It’s clear that the hospital is on a slow downward spiral as a city-owned entity,” he said. “And of everyone who put in a proposal, they picked the best one. The university is known nationally for its quality.”

In the end, it’s a trade-off, Berkshire said.

“Will they raise prices? Probably,” he said. “Will they bring higher quality as well? One hopes so.”

Memorial lease details

City of Colorado Springs receives

  • $74 million up-front lease payment
  • $185 million to resolve Public Employee’s Retirement Association issues
  • $330 million (available cash and investments) to pay off debts and bonds
  • $5.6 million annual payments (paid monthly) for first 30 years of the lease
  • $1.1 billion in capital improvements (annual expenditure of $28 million, but can be more/less than that)
  • Potential annual share of surplus MHS income. The city will receive 5 percent of any surplus higher than the 9 percent profit margin MHS currently has. That could equal $2.5 million annually.
  • City must keep $50 million to address any unforeseen liabilities that could arise in the first three years, and retain $25 million for the next two years.

UCH receives

  • $42.4 million of net working capital at transfer.
  • Promise of no property taxes on new Memorial.
  • Right of first refusal if the city chooses to sell any of the buildings or real property.

Governance

  • 11-member board to be chosen by a nominating committee. The nominating committee will have six members, three chosen by the city and three by UCH. Of the 11-member board, seven members will be from El Paso County, and must have lived in the county for at least a year.
  • Poudre Valley Health Care, Inc. will be the temporary holder of the lease, until a new 501c3 can be set up called Memorial Health System. UCH has 18 months to set up the new nonprofit, and until then, the hospital will be governed by a six-member board — three members from the city and three members chosen by UCH.
  • Children’s Hospital of the Colorado Health System will provide pediatric services at Memorial’s Children’s Hospital. It is sub-leasing the children’s hospital from UCH.
  • The new entity must maintain the “Memorial” name, but will probably be used in conjunction with University of Colorado Health.
  • Current Memorial becomes a shell entity for legal purposes, because city still owns land, buildings. Will have no assets.
  • After nine years, the parties can agree to an one-year extension, to create a rolling 30-year term from the 10th year forward. The city and UCH will agree on the extension every anniversary of the lease agreement. The rent during the extension term will be determined based on the fair market lease.
  • Annual report issued to the community, outlining Memorial’s financial status and progress.

Employees

  • 5,000 Memorial employees will retain their jobs, for at least six months. The lease agreement promises to maintain job titles and salaries during the first six months of the lease.
  • Employees currently vested in PERA would remain vested in the state’s retirement plan. UCH would also offer a retirement benefits plan for employees.

Foundation

  • City will form a new foundation to hold excess funds from lease partnership.
  • Council and mayor will collaborate on governance: selection of board, mission and use of funds, investment guidelines, protection of the original investment, and limits on use of funds.