New Questions for Niche Hospitals - TheStreet

Last holiday season,

Universal Health Services

(UHS) - Get Report

found itself confronting a familiar grinch.

A physician-owned hospital was once again stealing away choice business in McAllen, Texas, where Universal has a lucrative hospital of its own. The nation's first-ever cardiac hospital, launched by niche player

MedCath

( MDTH), had done exactly the same thing to the company less than a decade earlier.

In a December conference call with analysts, Universal blamed much of a fourth-quarter shortfall on the recurring phenomenon. But analysts wanted more answers.

"Obviously, you knew the hospital was coming on," said Margot Murtaugh of Snyder Capital. "Do

you think that you planned appropriately or not?"

In response, Universal sounded almost helpless.

"We're never sure when they build a new hospital what services they are going to have in there," said CEO Alan Miller. "They went after the cardiac business. ...

But we will compete very vigorously with them."

Last time around, Universal ultimately purchased the competition and expanded its own services in the process. This time, the company has indicated, it could wind up doing the same. Next time, some hope, simply will not happen.

Already, the government has established an 18-month ban -- and could follow with another -- on the development of new, physician-owned specialty hospitals. Medicare officials have spent the first moratorium, set to expire in June, examining whether specialty facilities hurt normal community hospitals and health care services in general. They did spot areas of concern but, because niche hospitals are still so new and so few, need more time to reach definite conclusions.

For now, however, the government seems unwilling to banish physician-owned hospitals altogether. Instead, it seems more inclined to suggest changes that would level a playing field that has tipped away from traditional hospitals, in favor of the specialty competition. Under the proposed arrangements, both types of hospitals could find themselves rewarded for partnering with physicians and delivering more efficient health care in the end.

"It's a new business model for hospitals," said Peter Young, a business consultant for HealthCare Strategic Issues. "It's the most significant matter that's been on the health care business table for years."

Physician Perks

Up to now, traditional hospitals have found themselves watching futilely as physicians drifted away and became the competition.

After all, who could blame the doctors? With limited revenue from payers like Medicare and soaring expenses -- especially for malpractice insurance -- doctors no longer enjoy the same kind of compensation they once did. Thus, they can stay put and keep making money for the community hospital. Or they can help finance a new specialty hospital and start creating a return for themselves.

Many physicians, especially those involved in lucrative fields such as cardiology and orthopedics, have chosen the latter path. And controversy has naturally followed.

"Doctors who refer patients to these places have a financial conflict of interest," declared U.S. Senator Chuck Grassley (R., Iowa) in a special hearing this week. "Not only do the physicians get a fee from Medicare for performing surgery on the patient, but they also get a fee for use of the hospital -- which they own. ... That's troubling."

Under current laws, traditional hospitals cannot reward physicians for referring them patients and making them money. Nor can they technically compensate physicians for saving them money, either. But the current debate could change things.

Already, Young noted, the Office of Inspector General has solicited suggestions for improvements from hospital players and even granted certain concessions to some. Last month, the Federation of American Hospitals -- which represents for-profit chains like

HCA

(HCA) - Get Report

and

Tenet Healthcare

(THC) - Get Report

-- asked for new ways to legally compensate physicians. Among other things, the group is seeking permission to offer malpractice insurance and free technology to more doctors. It is also hoping to alter a rule that actually requires physicians to perform a certain number of procedures at the surgery centers they own.

In the meantime, OIG last month also opened the door for hospitals to reward physicians who save them money. On at least three separate occasions, the OIG said it would seek no sanctions against hospitals for executing so-called gain-sharing agreements that split cost-savings -- particularly on medical supplies -- with certain medical groups.

"Such arrangements can potentially influence physician judgment to the detriment of patient care," the OIG acknowledged when issuing a recent opinion. But "properly structured, arrangements that share cost savings can serve legitimate business and medical purposes."

Young believes that big companies like HCA will soon reach out to physicians with such new offerings.

"This aligns both parties -- the doctors and the hospitals," he said. "It is an important step forward in an industry that has been notoriously inefficient."

Specialty Setbacks

Still, even specialty hospitals -- which enjoy that alignment already -- have clear room left for improvement.

The Medicare Payment Advisory Commission recently identified several deficiencies in the group. For instance, MedPAC found that niche hospitals tend to treat healthier cardiac patients more often than nonspecialty hospitals do. They also hospitalize those patients for shorter periods of time. But they still charge no less for their services.

To be fair, MedPAC acknowledged that it had studied only a small number of specialty hospitals over a short period of time. And it left open the possibility for new efficiencies in the still-evolving industry.

That said, even a "pioneer" like MedCath has encountered its share of challenges. After all, the company did not part with its first cardiac hospital out of a sense of generosity.

"They were not doing well," Miller reminded analysts during the December conference call. "And they sold to us."

Jeff Villwock, a hospital analyst at Caymus Partners, agrees that MedCath made some mistakes. For one thing, he says, the company "was not batting 1.000" when choosing where to locate its facilities.

Of course, the company faced limited options. Niche facilities must often locate in states that don't require so-called certificates of need for new hospitals. Currently, MedPAC found, nearly 60% of all specialty hospitals are situated in just four states. Of those states, only Texas -- home to MedCath's first cardiac hospital -- boasts a sizable population.

All in all, Villwock views the specialty hospital business as a difficult one for a publicly traded company like MedCath. He points to the huge expense involved in building state-of-the-art cardiac centers from the ground up. And he says that "Wall Street doesn't understand or doesn't want to understand" the long wait for a return.

Thus, he says, private companies -- owned by physicians rather than ordinary shareholders -- will probably be the ones hurt by any crackdown on niche facilities. Meanwhile, he says, MedCath has already adjusted its business model and moved on. He says the company is now more interested in acquiring regular community hospitals and transforming them into specialty "centers of excellence" than in building niche facilities from scratch. He doubts that any new moratorium on specialty hospitals will hurt the company as a result.

At the same time, he sees fresh opportunities for the hospital industry as a whole.

"Acute-care hospitals around the country could operate more efficiently" under the proposed changes, he says. "They could become better at providing health care. And that would be a net gain for everybody."