Assessing Converison Options 3: Guide to Communities Considering Hospital Conversion in the Carolinas

JOINT VENTURE
Definition: An arrangement in which two entities unite to form a new, jointly-owned entity whose scope may range from full-fledged operation of inpatient hospital entity, or joint operation of outpatient surgery center. Ownership of a joint venture entity is divided among the partners in the agreement. For example, a converting hospital may contribute assets to the partnership for which it may be reimbursed cash and an ownership stake in the joint venture (e.g., worth 20%). In the conversion of a not-for-profit hospital, a foundation typically would become the holder of the 20% interest in the venture. The other partner, often a for-profit entity, could contribute cash (or stock) worth 80% of the hospital's assets, in exchange for an 80% ownership interest in the venture. Joint ventures may also be structured with a 50/50-ownership stake.

* In 1995 the Sisters of St. Augustine of Providence Hospital in Columbia, SC and Columbia/HCA Hospital Corporation entered into a 50/50 joint venture agreement.

Issues to Consider
What percentage of ownership will the hospital have in the new venture?
Advocates of greater regulation of not-for-profit hospital conversion have suggested that, in a joint venture, a not-for-profit hospital is likely to cede control of the hospital, yet be paid for only a fraction of its value. A hospital may adjust the ownership stake in the joint venture (e.g. from 80/20 to 50/50), which would offer the converting hospital a larger interest in ownership and governing authority. However, some have raised concerns that maintaining a high stake interest in the hospital would give a foundation a large investment in the venture without the level of governing authority achieved by holding controlling interest. In contrast, the sale of a larger interest by a not-for-profit would liberate a greater percentage of assets to be used in other investment opportunities by the foundation, allowing for stronger potential for foundation giving.

Can a joint venture between a not-for-profit and a for-profit be classified as a tax-exempt entity?
The intermingling of assets in a joint venture between a not-for-profit and a for-profit hospital raises distinct questions regarding whether the charitable assets of the not-for-profit will now be used for a profit motive, rather than for their original charitable intent. Subsequently, questions arise as to whether a newly created joint venture will retain the desirable tax-exempt status of its not-for-profit progenitor.

New IRS guidelines issued on March 4, 1998 clarify the structure of the joint venture agreement and require that the joint venture must 'give charitable purpose priority over maximizing profits.' In order to maintain tax-exempt status in a joint venture agreement, the parties must prove that the partnership furthers the charitable mission of the not-for-profit assets and must not resulting in 'more than incidental' private benefit., Further, the IRS specifies that the not-for-profit partner in a joint venture 'must be the one to exert control', to ensure that such private gain does not occur, and that the not-for-profit must hold a majority of seats on the hospital board. While a joint venture may retain tax-exempt, the income earned by the not-for-profit from the joint venture may be subject to income tax. At this point, the IRS is developing revenue rulings that will address this issue.

MERGER
Definition: Integration of a hospital's assets, name and accounts with those of another entity, resulting in the survival of only one corporate identity. The new entity will be governed by a new management structure integrating various sectors of the previously distinct hospital entities. A horizontal merger occurs between two firms in the same line of business (i.e. two short-term acute care hospitals). Hospitals can merge with a neighboring hospital or merge into a system. A vertical merger occurs between companies in related lines of business (i.e. a short-term acute care hospital and a skilled nursing facility).

* A merger was not used to convert any of the case study hospitals. However, an example from the Carolinas is the merger of Moses H. Cone Memorial Hospital and Wesley Long Memorial Hospital in Greensboro, NC.

Issues to Consider
How will a merger agreement between hospitals fare against antitrust scrutiny? As competitive pressures in the health care sector continue to make hospital consolidation attractive, the tendency of hospitals to merge, rather than to loosely affiliate through alliances is growing. This enhanced activity has led to a corresponding increase in the investigation and legal challenge of these agreements by the antitrust enforcement agencies. Yet, those hospitals considering merger agreements must keep in mind the goal of antitrust statutes: the prevention of agreements that threaten consumers by anticompetitive actions resulting in higher prices. In this light, most merger arrangements are more likely to create efficiencies and intensify competition than to impede fee market competition. (Further detail on antitrust enforcement provided in Section VII.)

Will a merger result in a "weak sister?" After hospital mergers, there is a tendency to consolidate resources in better-off communities despite promises to maintain substantial resources at both. On the other hand, failure to achieve any sort of consolidation eliminates potential efficiency gains. The challenge is to achieve such gains in a mutually acceptable manner.

How will a merger affect hospital prices? In theory, a merger can produce efficiency gains that result in lower prices. A countervailing danger, however, is that by reducing competition, a merger will permit higher pricing.

There is only weak evidence that mergers in other industries have improved either efficiency or profitability. According to a study of horizontal hospital mergers between 1986 and 1994, those hospitals showing the largest merger-related cost and savings were those with low occupancy rates, and those that were non–teaching, non-system and not-for-profit. In general, these mergers produced savings in annual operating expenses for the merging organizations that were passed on to consumers as a 7% reduction in hospital prices. However, hospital mergers in geographic areas with high market density had less than 50% of the cost savings of mergers in sparse hospital concentration areas. Savings contrasts were also seen in areas of varying HMO density, with greater savings and price reductions for mergers located in high HMO membership areas.