A Context for Decision-Making: Guide to Communities Considering Hospital Conversion in the Carolinas

M ost communities do not wish to convert if they have other options for maintaining a viable independent hospital. Yet, they are faced with an increasingly competitive, cost-conscious health care marketplace. To remain attractive to paying patients, hospitals may have to finance expensive capital improvements to aging facilities and equipment. To better position themselves to compete in a world of increasing price-sensitive payers, they may feel pressures to join a larger hospital or health system. Rural hospitals are disproportionately vulnerable to such competitive pressures given their small size, older facilities and fewer strategic opportunities. Yet in rural communities, survival of the hospital takes on heightened importance insofar as closure may mean both the loss of a convenient source of care as well a significant loss to the local economy.

While hospital conversion may provide an opportunity for communities to address the financial and other issues troubling their hospitals, the potential movement of hospitals away from the heart of the community can evoke strong emotions and heated debate. In part, this may be due to hospital conversions changing the way that health care--a "particularly important and controversial good"--will be delivered. The hospitals at the heart of a conversion decision may long have provided communities with a sense of security that health care is close by, supported by the knowledge that decisions affecting hospital care will be made by those close to home whose loyalty is to the community.

Yet, for many communities, having a hospital means far more than just a place to obtain medical care. The hospital often is a town's second largest employer (behind the school system) providing career ladders for local citizens and a base of support for local volunteerism. The strong presence of a hospital in a community also can be an important factor in business location decisions. Citizens also may take pride in the facility as a symbol of progress, growth, and success.

What stimulates most communities to consider their options is the goal of maintaining the financial viability, and thus the presence of a hospital in the area. In one way or another, long-term survival of the hospital was an important motivation in all 10 conversions we studied.

WHY CONSIDER A HOSPITAL CONVERSION?
There are many different reasons a hospital might consider conversion, but some of the principal reasons include the following:

To avert closure and continue the hospital's mission
To obtain access to capital
To improve efficiency
To preserve or expand market share
To reduce regulatory constraints

The decision to convert may be made by a hospital under distinctly different situations. Profound organizational change is most likely to occur when "the wolf is at the door." Thus, at one extreme, a hospital may be under financial distress and facing the imminent threat of closure, signaled by declining occupancy rates and profit. At this point a hospital's governing board must determine whether or not it can, in good faith, continue to adhere to its charitable mission under its current ownership status. In such cases, conversion may be a very attractive means of obtaining a wealth of funds that can be directed towards greatly needed community services.

* Several studies have shown that hospitals that subsequently change ownership tend to have worse financial performance (e.g., lower profits, and relatively old assets) prior to conversion than similar hospitals, which opt not to convert.
* Poor financial performance was an important motivating factor in several of the Project HOPE case studies: half of the non-profit hospitals converting to for-profit status were losing money at the time of sale and several were on the brink of bankruptcy. The hospital boards saw little choice but to sell to an interested for-profit partner.

In other cases, the hospital may not yet be losing money, but may recognize the need to modernize or replace an aging facility. In some cases, it is easier to find a buyer willing to make heavy capital investments needed to restore the hospital to a more competitive posture than to go into debt or otherwise try to raise funds locally. Given some of the limitations of not-for-profit and public hospital ownership, for-profit ownership may provide more ready access to large amounts of capital through the sale of stock. This capital may be used by hospitals to modernize medical services or implement information systems that improve the ability to deliver cost-effective and high quality care.

* Two South Carolina hospitals were sold on the condition that the buyer build a new hospital within a specified time period in order to replace aging facilities too expensive to refurbish: Byerly Hospital and Upstate Carolina Medical Center. In other cases, a for-profit purchaser invested large amounts to expand or improve services following conversion: Hilton Head Hospital and Providence Hospital.
* A desire to upgrade plant and equipment was a factor in several of the Project HOPE case studies.8

For small or rural hospitals in particular, regardless of their current financial circumstances, conversion may significantly improve efficiency through better management, information systems, economies of scale and a lower cost of capital (due to size or tax advantages).

Finally, at the other extreme, the hospital currently may be financially healthy, yet has enough foresight to adapt to the possibility of adverse future changes. In particular, a growing number of hospitals recognize that they cannot survive as stand-alone facilities. So it is only a matter of time before they partner. Conversion may ensure the facility's long term economic stability by joining a larger system which improves their ability to contract with managed care plans or by shedding restrictions inhibiting their growth within a local market.

* In half of our cases, the hospital governing boards concluded that even though they were not yet in financial trouble, their hospitals could not survive over the long term as stand-alone facilities: Cape Fear Memorial Hospital, Hilton Head Hospital, Mary Black Memorial Hospital, Providence Hospital and Roanoke/Chowan Hospital. Also, by changing from a public hospital to a not-for-profit facility, Wake Medical Center was able to eliminate several important restrictions that prevented it from being able to compete including public bidding rules, disclosure requirements that could hamper sensitive negotiations and a prohibition on out-of-county partnerships.

Although a conversion decision may be a difficult and unpleasant one, many governing boards recognize that procrastination can be as risky as conversion.6 Waiting to sell may increase the risk that the net worth of the hospital will decline, a potential loss of a great deal of money for the community.

As difficult as it might be to make the decision, many governing boards ultimately conclude that by offering the best chance for the hospital to survive and prosper, an appropriately structured conversion—even though it means some loss of community control—is preferable to gambling that the hospital can survive without a major change.

In many ways, understanding why a hospital conversion is being considered may offer clues as to what type of change makes the most sense.

THE CONVERSION CONTINUUM
Conversion is not an all-or-nothing choice. For a community grown accustomed to having hospital both independent and locally controlled, the prospect of outright closure generally is viewed as the worst possible outcome. But in between these stark choices are many alternative arrangements offering the community varying degrees of involvement and control. In some cases, the community can retain ownership while ceding some operational control over day-to-day hospital management. In other cases, the community may lose ownership of the hospital in exchange for a legal commitment by the new owner to continue to provide community benefits.

Hospital Closure
Conversions among rural hospitals are closely related to closures, since both often are related to a crisis in financial performance, especially among hospitals that are small, in communities with weak local economies and/or operating in a competitive market.5

Communities fear the prospect of hospital closure for good reason. Evidence regarding rural hospital closures shows that in small rural counties where the local hospital closed, there are adverse effects on area employment and local area earnings that persist up to 5 years. Remote rural counties in which a hospital closed have experienced a 20 percent decline in physician supply. 12 An analysis of all hospital closures in 1996 showed that in most communities, residents are able to obtain emergency and inpatient services within 10 miles of the closed hospital. Nevertheless, closures tend to be located in communities with a higher percent of poor, Afro-American or Latino-American residents, all of whom have greater health needs. For these and other reasons, closures have been associated with patients deferring needed medical care due to inconvenience12 and (even in urban areas) a decline in health status among nearby residents.12

There are widely varying estimates of the economic impact of rural hospitals on local economies. Taking into account both the direct economic impact (i.e., local purchases by the hospital or its employees) and indirect effects (e.g., induced employment, tax payments and community benefits such as charity care), a rural hospital closure would result in an annual loss of $15,000 to $100,000 per bed. Thus, up to a point, it would be rational for a community to subsidize the hospital to prevent its failure. Even so, retaining an independent, locally controlled hospital may require tax increases or bond issues that are practically or politically infeasible.