The Perils of a Fire Sale in the Wake of the Pandemic

by Tom Robertson

Executive Director, Vizient Research Institute

Did you ever inflate a balloon to its absolute maximum capacity? Where another breath of air would cause it to explode? When the walls of the balloon were stretched so tightly and spread so thin that you worried about it making contact with a blade of grass? For health systems, strategy has long been about revenue enhancement, both organic growth and pricing leverage. Mergers and acquisitions have spoken of cost savings — of economies of scale — but the real value proposition has been largely a question of revenue … of putting more air into the balloon.

As we emerge from the financial crisis caused by the pandemic and its associated societal shutdown, there will be distressed assets in every industry, including health care, perhaps refueling another round of consolidation. Before applying “old normal” economic assumptions to a “new normal” environment, we would do well to exercise a bit of caution.

It’s worth remembering that a seller’s revenue is a buyer’s cost. Forbes magazine reports that the coronavirus pandemic will cost the U.S. economy $8 trillion. The federal government has already distributed over $3 trillion in economic recovery packages. To assume that the buyers of health care services will have unrestricted appetites over the next ten years may be optimistic. Revenue enhancement, and in particular the ability to increase unit prices following an acquisition, may have limited durability.  

It’s not difficult to imagine a future that includes a universally available federal health plan. Small employers — those that survive the economic shutdown — may struggle with the costs of private sector health insurance. Like so many things that were difficult to imagine before the pandemic yet seem unavoidable now, the emergence of a federal health plan that is available to anyone who wants it is not such a far-fetched idea. All-payer rate regulation would be required to establish competitive parity between public and private plans. Different providers could be paid different prices, but all payers would pay any given provider the same price. Negotiating leverage — in particular the opportunity for an organization to acquire a provider and increase their payment rates to those of the larger system — would disappear.

In a future that involved rate regulation, global spending budgets would not be far behind. Where rate regulation already has matured, such as Maryland, global spending budgets have been established. A health system’s budget for the coming year would be based on past experience plus an allowable rate of increase. In effect, it would be a zero-sum game. Like a balloon filled to capacity, a health system on a regulated revenue budget cannot simply add more air. If market share moved, money could follow (albeit with a time lag), but that money would come from another provider’s budget. If an acquisition brought a new entity into the system, along with its regulated revenue and its actual expenses, any economic gain would have to arise from increased efficiency, not enhanced revenue. The newly constituted system could attract incremental market share, and with it the associated (and regulated) revenue, but such organic growth would be the only revenue enhancement strategy available. Pricing leverage would be a thing of the past.

Not everything about rate regulation and global spending budgets would be bad for providers. During the pandemic shutdown, elective surgery volume all but disappeared and with it went the associated revenue. Hospitals struggled to survive financially. The unrealized provider revenue became a windfall to insurers who had no surgical claims to pay. Under regulated global budgets, revenue would have been fungible. Providers would have been able to use budgeted surgical revenue to cover the costs of treating medical patients. The air would have still been in the balloon.

It would be interesting to look retrospectively at already completed mergers and acquisitions and to ask if those transactions would have been economically compelling if organic growth and cost reduction alone were in play. If a rate-regulated environment had meant that the new acquisition brought with it a capped revenue budget, would increased operating efficiency have been enough to merit the transaction?

As we emerge from the shutdown, it’s reasonable to expect a resurgence of merger and acquisition conversations. There will be distressed assets and distressed assets commonly trigger discussions. Traditional strategies — in particular, converting lower private sector payment rates to higher system prices — may have a shorter half-life than they did just a few months ago.

The emergence of all-payer rate regulation is hardly a sure thing, but the prospects for its eventual adoption are considerably higher after the pandemic than they were before. Were it to come, it would fundamentally change the dynamics of health system mergers and acquisitions. Regulated health systems could add air to their balloon only after releasing some first — increasing some clinical programs while shrinking others — or they would need to take the air from someone else’s balloon. The time-honored assumption of virtually unlimited air would no longer hold. As we come out of the economic shutdown and contemplate the merits of even more provider consolidation, it may be worth considering the eventual emergence of rate regulation and its impact on the assumptions underlying any potential transaction. Two words come to mind as we look toward the horizon: caveat emptor.