Developing Conversion Package 2: Guide to Communities Considering Hospital Conversion in the Carolinas

COMPONENTS OF A REIMBURSEMENT PACKAGE
Having reaffirmed a hospital's mission and determined its fair market value, a governing board must determine the second portion of the decision to convert: for what compensation? Whether negotiating a lease, merger or sale, and regardless of the ultimate taxable status (not-for-profit or for-profit), a hospital must develop or have an idea of a reimbursement package—monetary and non-monetary—that will compensate that hospital adequately for the value of its assets (tangible and intangible).

The awareness resulting from a long history of conversions is changing how reimbursement is viewed, especially for the not-for-profit and county hospitals that were typically not aggressive in the early conversions. The deputy Attorney General of California suggests that the negotiation vigor of the nonprofit hospital on behalf of the public should be "no less" than that of the management of for-profit health chains.

While reimbursement may include the traditional use of cash or equity, a hospital may develop a conversion package to include a combination of any number of attractive components, described in what follows. This ability to combine a price with a wide range of other reimbursement options allows the hospital governing board to tailor a package to meet the needs of both the hospital and community.

The importance of the inclusion of these elements may be so great that a hospital may decide to limit its suitors based upon the inclusion of a particular item. Byerly Hospital issued a Request For Proposals (RFP) outlining several specific elements desired in a conversion agreement: commitments to build a new hospital facility within five years, to continue to serve the county's indigent population and to attract new physicians to the area. The hospital ultimately selected a buyer based, in part, on the purchaser's willingness to commit to building the new facility. This point was important enough to Byerly Hospital that the hospital board bypassed the highest bidder and decided to deal with a buyer they were confident would build a new hospital for the community.

Cash settlements may comprise a large portion of a conversion package and may be used in different ways by a hospital, depending upon the type of facility. When a not-for-profit hospital converts to for-profit status, legal statutes mandate that the cash and assets set as a conversion price for that hospital be managed through the use of a foundation (See Section VI). In contrast, the conversion of a county hospital allows greater freedom to determine how to be reimbursed and how this money will be used. In both cases, the community has an interest in seeing that the proceeds are put to good use.

What Might Substitute for Cash Payments?
In many conversion agreements, there are provisions obligating the new owner to provide specified community benefits. These agreements—known as "covenants"—take a wide variety of forms. These obligations might be viewed as "in-kind" rather than direct cash payments insofar as the cash price will vary depending on the nature and magnitude of such obligations. The following illustrates the many different types of such elements that could be included in a hospital conversion package. In some cases, the hospital governing board will know in advance certain non-negotiable terms to be included in an agreement (e.g., to continue indigent care). If so, these elements might be included in an RFP. In other cases, specific terms and conditions result from the give-and-take of negotiating with a final bidder over the exact details of a transaction.

Revisiting the Conversion Question:
How much control are we willing to give up, and for what compensation?

Transfer of Financial Obligations
In for-profit acquisitions in particular, it is common for the buyer to assume the converting hospital's long-term debt, especially since for-profit chains often are in a position to substitute less expensive forms of debt. But the buyer might also relieve the seller of other financial obligations such as county indigent care payments or other financial liabilities.

* In the Roanoke-Chowan conversion, the lessee agreed to assume the hospital's long-term debt as a part of the lease agreement. In the event of failure, the agreement specified that this amount would have to be paid by the lessee in the case of hospital failure. In the Piedmont Medical Center conversion, a for-profit purchaser agreed to assume payment of the county Medicaid tax in perpetuity.

Covenants Addressing Access
Continuation of indigent care is an important issue in many conversions, with many seeking to continue indigent care at "historical levels." This is an area in which careful specification within the agreement can avoid future disputes over compliance. This may include identifying who is covered (e.g., out-of-county residents?), what is covered (e.g., how operationally will indigent care be measured?), when (e.g., for 5 years? In perpetuity?), and where (e.g., does it only apply to inpatient services or would outpatient, home health or other hospital activities be included?). Such provisions must be crafted with care to take into account inflation, ability to monitor/enforce, avoidance of measurement manipulation (i.e., a commitment measured in terms of charges may not accurately reflect actual care provided, whereas a commitment based on costs might) and what happens if the hospital falls short of an agreed-upon standard despite a good faith effort.

* In all 10 of our case studies, there were explicit agreements regarding indigent care. In some cases, these entailed explicit dollar payments for indigent-related activities, while in other cases, the agreement stipulated that indigent care would be maintained at "historical levels" or in line with "similar" facilities. In some cases, such provisions were for a specified period of time ranging from 5 to 20 years, whereas in other cases, the obligation remained in force in perpetuity. Likewise, in some cases, the obligation was specified in a very measurable way, whereas in other agreements neither the method of measuring compliance nor a means of monitoring were specified.

Covenants Addressing Costs
A community can attempt to guard against high prices by including provisions to address this issue. Enforcement may be difficult, however, since a hospital offers a multiplicity of prices and comparative price data are difficult or expensive to acquire or may be proprietary.

* In the Upstate Carolina Medical Center case, the for-profit purchaser agreed to maintain prices at competitive levels relative to neighboring facilities.

Covenants Addressing Quality
To ensure the hospital is modernized and not permitted to become run down, some agreements include guarantees of capital investments and/or expanded services. A properly written contract can guarantee capital investments to meet contractually defined community medical needs without further community input. In addition, with the guarantee of large capital investments (e.g., a new hospital), a community has greater assurance that the new owner has incentive to realize profit from this investment, and will maintain the hospital's presence in the area.

However, when agreeing to accept a guarantee of investments as a portion of a conversion package, the board of a converting hospital must realize that realistically, the ability of an acquiring hospital to follow through with its guarantees depends upon the limitations imposed by that state's Certificate of Need (CON) process. Proposed changes above a certain cost threshold require CON approval, as well as limitations by market factors that may be beyond the purchaser's control.

Eight of the 10 Carolinas conversions specified plans for capital investment in the converting hospital, including two hospitals that were built to replace existing facilities. Hospitals made additions such as birthing centers and skilled nursing beds, and updated service capabilities such as cardiac catheterization, rehabilitation, neurosurgery, open heart surgery and the emergency room. Of the 8, the Piedmont Regional Medical Center its conversion agreement set forth a schedule of investments in the greatest detail. In addition to outlining the changes to be made by the acquiring hospital, the agreement specified estimated cost and target dates for completion of specific projects, taking into account the need for individual state regulatory approval (e.g. CON).

Covenants Addressing Economic Impact
An acquiring entity may agree to put into place a moratorium on job cuts for a period of time after the conversion takes place; agree to recruit more physicians into the area; provide assurances of financial or other support for a community health center. Some caution is in order in crafting such agreements: for example, an agreement not to lay off workers may prevent the hospital from becoming more efficient, thereby jeopardizing its future financial stability.

* A promise of no layoffs for the first three years after hospital conversion was made by Duke University Medical Center as part of its bid for Durham Regional Medical Center (Durham, NC), with any necessary adjustments in workforce to be achieved through employee reassignment and retraining.