Over the past several decades, both freestanding hospitals and integrated healthcare delivery systems have employed physicians and placed them into separate operating units called Medical Group Enterprises (MGEs).
The number of physician practices owned by hospitals has in-creased 86% over the past four years, with a corresponding 50% rise in the number of physi-cians employed by hospitals.1 By 2016, nearly 4 of 10 physicians were employed by a hospi-tal and one in four practices owned by a hospital.1
There are many reasons why healthcare systems and physicians opt for employment. Healthcare systems desire to retain a physician’s patient panel in order to create networks that offer patients a broader range of clinical services directed at the system’s other programs. The goal is that employment will align physicians to help capture or maintain market share and to al-low systems to compete in value-driven or population-based market niches (such as accounta-ble care organizations [ACOs] or Bundled Payments for Care Improvement projects) to create clinically integrated networks (CINs) and combat the narrowing of networks and panels of com-mercial insurers. Further, physicians may prefer the security of employment rather than trying to manage their clinics through a difficult phase of healthcare reform and dynamic marketplace evolution.
These patient acquisition strategies are expensive, especially compared to the recent past, where independent physicians would bring their patients to hospitals with few expenses incurred by the hospital. MGEs were developed by healthcare systems to create a secure and stable workforce of physicians to build, cover, or support acute care–focused clinical programs. Too often, however, MGE creation coincided and collided with other tactics focused on the acute care hospital and acute care–focused specialty practices or service lines (SLs). This bifurcation of provider alignment activities often fractured the financial accountability for developing these programs.
Goldsmith and colleagues2 outline common pitfalls in the oscillating and wishful nature of some healthcare system strategies and tactics: swinging from a “grab market share” approach to a “respond to competitive acquisitions” approach to “bailout” maneuvers for loyal independent phy-sicians to an “increase bargaining power with payer’s scheme” to a “position for value-based care” platform. While one or more of these strategies can be successful, having multiple, dispar-ate, and often conflicting philosophies creates confusion of purpose and an operational quag-mire. Unfortunately, many healthcare systems end up owning disconnected clusters of providers with multimillion-dollar losses. Having a clear, complete, and committed strategy with a defined MGE return on investment (ROI) to the system is a critical and foundational first step.
Within a few years, margins for many hospitals have deteriorated even as MGE losses per phy-sician increased from 10% of net revenue in 2016 to 17.5% of net revenue in 2017.3 Within inte-grated health systems, the losses are more dramatic. The median operating loss per physician employed by integrated health systems in 2017 was $243,918, an increase of 15% over the 2016 median loss.3 Simultaneously, the median net professional revenue decreased, consistent with a combined increase in expense in the face of falling revenues.4 The dichotomy may be even more stark because the expected downstream revenue generated by patient volume in the hos-pital and ancillary departments and by referrals to affiliated physicians—assuming they can be accurately tracked—may be absent.5
We think it is time to pause and ask several crucial questions. What is the role and function of an MGE within the system? What are the expected outcomes? How is success defined? As cur-rently configured and tracked, MGEs often appear to have negative EBITDA margins. Does this truly reflect their value, or do they have a large unaccounted intrinsic value? Does the healthcare system’s accounting attribution methodology truly reflect the value of MGEs? These questions showcase future challenges and opportunities for MGEs.
The Function and Attributes of a High-Performing MGE
In an optimally integrated system, MGEs are the operational units charged with, and responsible for, ambulatory care operations, including clinics; ambulatory surgical centers; and endoscopy, laboratory, and imaging centers—with the integration of a diverse workforce of clinicians and caregivers in multiple, nonacute settings. These units should be created to ensure MGEs deliver superior operational performance, maximize ambulatory market opportunity, and drive appropri-ate network integrity. High-functioning MGEs typically fulfill both the system’s market aspirations and the Quadruple Aim (excellence in quality, patient experience, and provider and staff experi-ence, and a reduction in the cost of care across the continuum).
Measuring MGE Value
The typical financial valuation of an MGE is based on the future values of free cash flows asso-ciated with its EBITDA margin. However, most MGEs within healthcare systems appear to have an attributed negative operating margin. Therefore, what is the true value of an MGE, and how do healthcare systems make decisions to invest in clinical programs?
The actual value of the MGE is the sum of its operating cash flows and its intrinsic value to the system. Each clinical program or provider may generate negative cash flows within the MGE but substantive positive cash flows downstream in the healthcare system. These total cash flows must be recognized and tracked to calculate their internal rate of return (IRR) or ROI, with ac-ceptable IRR and ROI viability thresholds for each program reflecting its risk or strategic im-portance.
While there is currently no “perfect” calculation, the Advisory Board developed an index to evaluate an MGE’s global performance: the physician enterprise value (PEV). PEV = health system contribution margin ÷ MGE loss. A PEV of greater than 5 indicates a high-performing MGE.6 The PEV provides an overall assessment of operational performance, as well as a near-term look at recent and future investments in capital, people, or programs.
MGE Financial Accounting: Time for Change
Financial accounting systems distort MGE value by inappropriately allocating revenue and costs. Currently, most MGEs are evaluated by their free cash flows or EBITDA margins. MGEs em-ploy physicians with an eye to their holistic value to the system, but most of the time MGEs do not receive credit when that value lies downstream near or within the hospital. Healthcare sys-tems that utilize provider-based billing allocate laboratory, imaging, endoscopy, and ambulatory surgical center revenues to hospitals due to reimbursement arbitrage.
The accounting system also distorts the financial accountability that exists in MGEs, hospitals, and SLs. Unless physician compensation and practice overhead costs are directly covered by the hospital in proportion to “all in” revenue and expenses, a physician who joins the MGE ap-pears as an incremental MGE loss even as the incremental hospital profit rises. SLs may inad-vertently contribute to this because they are focused on growth but are not fully accountable for profit and loss (P&L) across the enterprise. Also, in too many systems, the scrutiny applied to the entire ecosystem of employing physicians and other providers is often given less attention than the acute care operating budget or the capital allocation.
Just as the cost of owning a house is several times greater than the purchase price alone, so too the cost of employing physicians and creating a sustainable long-term structure. A thriving MGE requires integrated system planning, clarity regarding P&L and operational responsibility, and ac-knowledgment of revenue generation across the enterprise.
Optimizing MGE Value
There are numerous ways that MGEs can create value beyond their operational cash flows or perceived EBIDTA margins:
• Ensuring professional management of the ambulatory or non-acute units.
• Focusing on being a prime—if not the central—source of patient access to the system and the means to optimize clinically appropriate network integrity.
• Assuming responsibility for ensuring excellent quality, safety, outcomes, and total cost of care across the continuum.
• Realizing improved pay-for-performance metrics due to an aligned provider continuum.
• Serving as the foundation for clinical integration within healthcare systems through the enhanced operations above.
• Forging tighter horizontal integration by rightsizing providers and clinics into established or new markets in an existing fixed-cost infrastructure. Vertically, the MGE allows the sys-tem to offer its own or partner’s insurance components, including within the system’s employee health solutions.
• Improving partnerships throughout the system in other spheres of operations, such as with supply chain, pharmacy, information technology, and other entities to have clinicians help drive out variation that is not additive.
• Becoming the backbone of CINs in a market to improve care, reduce the total cost of care, and enhance access. CINs built around an MGE can generate 50% to 90% of a system’s total net patient service revenues and create reinforcing cycles of access and care integrity in competitive markets.
• Utilizing the CIN to become the platform for an ACO. However, the CIN must be con-structed carefully to meet the needs of the patients and providers on an “equal footing” with hospitals in the system to prevent silos and duplication of services, particularly when resources are strategically placed to cover call or offer market coverage.
Conclusions
Healthcare systems currently employ physicians to secure a stable workforce for their clinical programs and as a patient acquisition strategy. In isolation, this is expensive. Healthcare system margins have been deteriorating industry-wide and will continue to face pressure. Even as phy-sicians and practices have been acquired to preserve or extend hospital volumes, MGE losses per physician have increased. This has called into question the value and ROI of MGEs.
However, MGEs have synergistic and intrinsic value beyond the free cash flows or EBITDA margins they generate and by which, in isolation, they are frequently assessed. Therefore, we believe MGEs should be structured and evaluated according to the following principles:
• MGEs should be viewed as the ambulatory engine of the health system.
MGEs need to be reconceived as foundational operational units across the entire ambu-latory space, which is half the business of most health systems. MGEs can create value by enhancing patient access; leveraging better reimbursement rates and supply chain management costs; and increasing patient acquisition through improving quality, pa-tient/provider experience, and clinical integration within the healthcare system.
• CIN financial and operational accountability should be a joint healthcare system responsibility.
Employed CINs are developed primarily for strategic coverage of call or clinical pro-grams. These “strategic hires” are expensive and frequently made in silos as piecemeal reactions to specific markets, programs, or hospitals. MGEs often have limited input into hiring these providers but are subsequently responsible for funding and supporting them while not being given operational or financial control. This leads to inappropriate hires, expensive relationships, and a lack of operational accountability. These issues can be avoided by integrating the CIN oversight process to include hospital and MGE leadership. Doing so would allow for mutually agreed-upon hospital/MGE decision-making regarding hiring, financial support, and management of aligned providers.
• Value should be assessed based on an MGE’s total system impact.
Basing MGE value on an investment per physician when the MGE is not credited with ancillaries or downstream revenue is an incomplete and inappropriate calculation. The real rate of return must calculate the MGE’s IRR or ROI to the system, which requires including downstream cash flows, as accounted for in the Advisory Board’s PEV.
Endnotes
1. “Hospital Ownership of Physician Practices on the Rise” (Medical Economics, Septem-ber 24, 2016), https://www.medicaleconomics.com/medical-economics-blog/hospital-ownership-physician-practices-rise.
2. J. Goldsmith, A. Hunter, and A. Strauss, “Do Most Hospitals Benefit from Directly Employing Physicians?” (Harvard Business Review, May 29, 2018), https://hbr.org/2018/05/do-most-hospitals-benefit-from-directly-employing-physicians.
3. K. Gooch, “Operating Loss per Physician Grows to 17.5% of Net Revenue: 6 AMGA Survey Findings” (Becker’s Hospital CFO Report, January 8, 2018), https://www.beckershospitalreview.com/finance/operating-loss-per-physician-grows-to-17-5-of-net-revenue-6-amga-survey-findings.html.
4. J. Finnegan, “Cost Up, Revenues Down for Medical Groups, Survey Finds,” (FierceHealthcare, January 9, 2018), https://www.fiercehealthcare.com/practices/for-doctors-costs-go-up-revenues-go-down-amga-survey-fred-horton.
5. P.M. Zalucki, “Factors Contributing to Financial Losses of Hospital-Employed Physician Groups” (August 2018), https://www.researchgate.net/publication/328662072_Factors_Contributing_to_Financial_Losses_of_Hospital-Employed_Physician_Groups.
6. J. Deane and A. Bryan, “Improve Care vs. Increase Margins? Why Your Medical Group Shouldn’t Make That Choice” (July 7, 2017), https://www.advisory.com/research/medical-group-strategy-council/practice-notes/2017/07/pev?WT.ac=Feat+Ben_MGSC_Blog_RESEARCH+DOM_x_ImproveCareIncreaseMargins_1_Q317_Eloqua-MKTG+Web.