GR Hospital Merger Gets Good Grade

October 5, 2007
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GRAND RAPIDS — The 1997 merger that created Spectrum Health scuttled long-discussed plans to build a new Blodgett Memorial Medical Center. Grand Rapids’ health care industry has still added bricks and mortar, Spectrum Health CFO Mike Freed said.

“We did build a new Blodgett building,” said Freed, his arm sweeping toward office windows overlooking hospital construction along Michigan Street. “It’s right here.”

Several local business leaders, asked by the Business Journal to reflect on changes in health care in the 10 years since Blodgett and Butterworth hospitals melded into Spectrum Health, offered mixed perspectives. They agreed that the nonprofit Spectrum Health, growing from a $750 million enterprise at its inception to $2.6 billion today, has been a major player in a growing segment of a limping local economy. They shuddered to think that Grand Rapids could have had another hospital on a building binge, had Blodgett and Butterworth remained separate.

“I think we’ve saved money,” said Win Irwin, CEO of Irwin Seating Co. and a member of the financial advisory board which oversaw Spectrum’s court-ordered community commitments.

“The single biggest positive for the community is that prior to the merger there was talk about a lot of capital expenditures. And the way health care works, we all pay with our premiums for those capital expenditures. Albeit they are replacing buildings, overall it’s better for the community and there’s been less capital expenditure as a result of it.”

Bob Herr, retired partner at Crowe Chizek, chaired the Saint Mary’s Health Care board at the time of the merger and now is part of the West Michigan Advisory Board for Blue Cross Blue Shield of Michigan, the state’s largest insurer. “The significant change, I think, is the position that Spectrum is in as being the largest provider,” he said.

“They are certainly market-dominant, and also own what now is developing into the largest payer: Priority (Health). From a business perspective, I can’t get comfortable with that. It feels problematic to me.”

Spectrum Health owns 95 percent of Priority Health. Munson Health Care in Traverse City and Northern Michigan Regional Health System in Petoskey share the remaining 5 percent. According to the system’s 2006 audit, Priority Health provided $1.1 billion of the system’s total $2.1 billion in operating revenue.

The September 1997 decision from federal Judge David McKeague that paved the way for the merger has drawn criticism from academics and former FTC regulators in the ensuing years. Commentary has focused on two of McKeague’s points: that nonprofit hospitals behave differently in the marketplace than for-profit organizations, and that he allowed Priority Health, which began as Butterworth’s health maintenance organization, to remain in the Spectrum fold.

In a study published in 1999 in Health Affairs, three health policy experts disputed the lone 1995 study on which McKeague based his opinion. At the time, the 1995 study was the only empirical work on the pricing behavior of nonprofit hospitals.

“We show that merging nonprofits can be expected to raise their prices, not lower them, and that those price increases are greater when the merged hospital’s market share is greater,” the trio of researchers stated. With the merger, Spectrum commanded anywhere from 47 percent to 70 percent of the local market share, depending on how the type of care is measured. “In our opinion, the judge’s exclusive focus on ownership led him to the wrong decision.”

Spectrum Health CEO Rick Breon said the health care system takes its nonprofit status seriously.

“Our commitment to doing things with our community is much stronger than the $6 million that we dole out every year. It’s much larger than that. But the fact of the matter is, if you don’t use business acumen to make decisions, you’re going to be in trouble.”

David Balto and Meleah Geertsma, who worked for the FTC, returned to Grand Rapids in 2000 and conducted extensive interviews reported in a Journal of Health Law article, “A Retrospective on the Butterworth Merger.” They contended that the merger hampered new health coverage providers in entering the market, and stymied the local managed care market.

“Over the past three years, Priority has moved into a more dominant position and currently accounts for more than 50 percent of the market,” they wrote seven years ago. They noted that “some employers and managed care providers” complained that Priority Health received favorable treatment from its parent, Spectrum, blocking competition and prompting premium increases for businesses. The authors stated that they were unable to prove the allegations, but concluded: “In this situation, courts or administrative agencies should either require the divestiture of the managed care entity or simply block the merger.”

“When the payer and the provider are under the same umbrella, how level is that playing field to the providers?” Herr said.

Mike Jandernoa, a West Michigan businessman who formerly ran Allegan pharmaceutical maker Perrigo Co., said he’s been impressed with results of the merger but hears grumbling about ownership of the area’s largest insurer giving Spectrum “too much clout.”

“I would say the majority of people do not favor that,” said Jandernoa, a principal at Bridge Street Capital Partners. “That’s more clout than straight competition.”

Freed said he thinks Priority Health has delivered good products at good prices and dismissed the idea that Spectrum should have jettisoned it.

“We're a much bigger insurer than we ever were back then,” Freed said. “I don't think there’s been any doubt that it (Priority Health) has been good for West Michigan. It’s certainly promoted competition by having it. But even more importantly, I think Priority Health is a critical community asset.”

If Priority Health had disappeared at the time of the merger and a major insurer from Detroit or Chicago had filled the void, Freed said, he believes West Michigan employers would be paying 7 percent to 10 percent, or $300 million to $350 million, more annually for premiums today.

“We'll pay for local costs and local quality and we'll distribute it to the marketplace here in a way that makes sure that those cost savings get passed on to local businesses and don’t get passed on to businesses in New York City or to shareholders,” Freed said. “We consistently have very low health insurance rates here in West Michigan.

“Anybody who wants to come to West Michigan to compete with Priority, they have to pay attention and they have to compete. And I think they do. Blue Cross does an excellent job of competing. I think it's helped everybody sharpen their pencil and, if anything, promoted competition here.”

“There are really two major payers other than the government: Blue Cross and Priority Health,” Breon added. “I think that competition is healthy for this community.”

Earlier this year, the FTC reviewed Evanston Northwest Healthcare Corp.’s 2000 acquisition of Highland Park Hospital in the Chicago area and decided it violated the Clayton Act. The remedy: The federal agency required the hospital system to create two teams — one for the original two hospitals and one for Highland Park — to negotiate separately with managed care companies on discount rates.

FTC spokesman Mitch Katz said the agency’s investigations are secret and he could not comment on whether the FTC is reviewing any other hospital mergers.

“Nobody is going out of business because of their particular Spectrum Health discount,” Freed said. “There's not a lot of variety in local discounts. I know what those rates are, and if I was competing using any one of them, I would say I still have a viable product. If there was a huge spread, then I would say they've got a legitimate beef, but we've tried real hard to make sure that's not the case.”

At the beginning, the merged organization struggled with the bottom line. McKeague’s court order prevented Spectrum Health from raising prices for three years, and limited them for the next four. Operating margins sank. One hundred people were laid off, other jobs were left unfilled, and staff members endured pay cuts as high as 15 percent.

Freed said Spectrum Health now is financially healthy. “Very strong,” he said, noting that it retained an Aa credit rating even through those difficult early years.

Spectrum Health is bound by the court to keep its margins within certain levels: The five-year rolling average total margin for the health care system must be equal to or less than the upper quartile of other Aa-rated, single-state hospital systems, as reported by Moody’s Outlook. In May, Spectrum reported a consolidated 5.3 percent margin for the first three quarters of fiscal 2007, and a rolling five-year average of 3.29 percent, compared to the Moody’s benchmark of 7.5 percent.

Spectrum Health raised prices by 7.5 percent on July 1 and expects a 3.4 percent margin for fiscal 2008.

“In the for-profit world, everybody is worried about what the next quarter's earnings are, and they pretty much live quarter to quarter,” Freed said. “I think if we had done that at Spectrum Health, we would have made a tremendous number of mistakes. We had several years where we lost a little bit of money from operations, where we had almost no margin. That would not have been tolerated in a publicly traded company, but it was tolerated here because the board had a bigger vision.”

Jandernoa invests in the health care and life sciences industries. He said he sees much opportunity in the sector and thinks the sum of collaboration among Grand Rapids organizations is greater than its parts. 

“The new heart center, the children’s hospital, the cancer center — those aspects are really exciting and very positive for our community, especially in these economic times, to have that strength of the health care industry, enabling our little piece of Michigan to do better than the rest of the state of Michigan,” he said.

Added Irwin: “The community has continued to say, ‘You all need to work together on big issues.’ Metro Health, Saint Mary’s and Spectrum have done that. They’re competitive every day, too, of course. We’re lucky to have three very strong health care systems.”    

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