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 Part 4: Running on the edge Thursday, January 21, 1999
By January 1998, Bill Snyder had had enough. He’d been deluged with complaints that Allegheny wasn’t paying its bills. For some time, the health care giant had been stretching out its payments to suppliers, from 60 to 90 days and beyond. It was a way to preserve cash, an increasingly rare commodity these days. And it wasn’t as if Allegheny was the only one in the health care industry doing it. Insurance companies were notorious for waiting 90 days or longer to pay hospitals for services. But several suppliers weren’t willing to take it anymore, and they let Snyder, chairman of Allegheny’s parent foundation, know. He called Harry Edelman, a longtime member of the organization’s board and chairman of a group of Allegheny’s Philadelphia hospitals where the suppliers were complaining the loudest. Snyder wanted to know what the heck was going on — and to make sure that the glitch in the system got fixed so that suppliers could get their money. If only it had been just a glitch. A decade of spending — on hospital mergers, new offices and renovations, on doctors, escalating salaries and executive perks — had caught up to the health care giant. Money was going out a lot faster than it was coming in. And the well of reserves that had seemed so deep a decade before was running dry. There had been steep cutbacks the previous October, when Allegheny axed 1,200 Philadelphia hospital workers and vowed to slash the pay of top managers by 20 percent. That was on top of another 500 workers who were laid off with the closure of its Mt. Sinai hospital, acquired as part of the Graduate Health System merger the year before. It was hoped the cost-cutting measures would stem the rising tide of red ink, but the losses just kept coming. And the problems went much deeper than declining government reimbursements and the increasing power of cost-conscious managed-care insurance plans. Years of miscalculations, missteps and running on the edge were taking their toll. To many, the Graduate merger was the final straw. Outsiders and even some high-ranking insiders couldn’t understand this one. It’s true that the earlier acquisitions of the MCP and Hahnemann medical schools, their hospitals and the United group of hospitals had appeared to work out. The hospitals were making money, which was more than many of their brethren were doing. But profit margins were starting to erode, just as they were at hospitals throughout Philadelphia, the state and the nation. From fiscal 1994 to fiscal 1995, the United group and its St. Chris affiliate reported that revenue over expenses — hospital-speak for income — nearly doubled, from a combined $9.6 million to $15.7 million, before falling back to a combined $3.3 million in the fiscal year ended June 1996. And MCP and Hahnemann, which had merged to form one medical school, were losing money on operations — their day-to-day costs. But they also were bringing new money in — federal and private research dollars at the combined schools totaled $75 million in fiscal 1996, and would top $120 million a year later. In contrast, Allegheny General a decade earlier — when it had no medical school — took in less than $10 million for research. The MCP-Hahnemann faculty wasn’t getting along all that well. But combine any two schools and there would be clashes, particularly med schools, where egos are sensitive and often unyielding. The bottom line: As 1997 was approaching, the board was comfortable that Allegheny’s Philadelphia experiment was working, but that it needed more time to work out the kinks. And it bought into the idea that, in a struggling market, the best defense is a good offense: Buy market share on the cheap and, when the good times start rolling again, you make out like a bandit. For Snyder and other board members, these were heady times. Allegheny’s strategy was paying dividends. It had more than quadrupled in size in less than 10 years, and had risen in stature in medical circles, attracting big-name researchers and serving as a new model for growth and survival in the pressure-packed health care business. Still, Graduate, which Allegheny began managing in the summer of 1996 and formally acquired the following spring, presented a challenge. It came with a lot of problems, the least of which was that its hospitals were drifting into the red. A dispute with the region’s biggest insurer, Independence Blue Cross, threatened to drive business away. Independence had made a stab at buying Graduate in 1994, and there remained bad blood. And four of Graduate’s six medical facilities, including its flagship hospital, were in the city, where over-capacity and a high concentration of poor patients made for a deadly fiscal mix. Graduate’s network of hospitals had been patched together over the past decade, and its management feared it was still too small to survive on its own in the ever-tougher environment of medicine in the 1990s. Graduate also brought to the table $174 million of debt, primarily bonds assigned junk ratings by the major credit-rating agencies. At the time, Abdelhak said the debt would remain Graduate’s responsibility, but ultimately it ended up under the Allegheny umbrella. Maybe that wouldn’t have been so bad if Allegheny had also obtained Graduate’s pot of gold — about $70 million in reserves from the previous sale of a managed-care venture. But that money would stay with Graduate’s surviving foundation, which was not part of the deal.
But Abdelhak was a builder, and a convincing one at that. With Graduate, he told the board, he could build the biggest hospital system in Philadelphia, leapfrogging past No. 1 University of Pennsylvania and No. 2 Jefferson Health Systems, with a 13 percent share of metropolitan Philadelphia hospital beds. He had designs on creating a nationally renowned sports medicine center, as well as a women’s hospital, filling holes in Allegheny’s Philadelphia network. Allegheny also would pick up Graduate’s physician practices subsidiary, adding 100 doctors to its growing network. Remember: If you control the hospitals and doctors, you have more control over your destiny. And as the biggest kid on the block, Allegheny would have more control than anyone. It was time to let the world know it. Allegheny hung its banner on its Philadelphia-area hospitals and its medical school, putting them all under the Allegheny University name. (The signs were often just canvas, presenting no problems two years later when new owner Tenet Healthcare took them down to put up its own.) It struck a multimillion-dollar deal for advertising and promotions with the Philadelphia Eagles and Veterans Stadium. And the big-bucks announcements kept coming: In October 1996, it committed $100 million to cancer research; in December 1996, it created a New Jersey subsidiary and pledged to grow it to six or seven hospitals; and in March 1997, it unveiled plans for two Center City buildings totaling 450,000 square feet and costing $100 million. But even as it was drawing the attention and praise of political leaders who saw the promise of jobs and prosperity, the pillars were starting to crack. The announcement that Graduate’s Mt. Sinai hospital would close came in August 1997, followed by the 1,200 layoffs in the Graduate system in October. Allegheny tried to put the best spin on the situation. It said it remained committed to Philadelphia and that Pittsburgh wouldn’t be affected. But as often was the case, what Allegheny said was at odds with reality. The truth was, the empire was coming apart at the seams. Just as it was completing its takeover of Graduate, the full impact of revenue-reducing changes in Medicaid and Medicare programs — which shifted a large portion of recipients into managed-care plans and forced hospitals to accept more free-care patients — started to hit. By the end of 1997, Allegheny officials estimated, those pressures were reducing revenue at their Philadelphia hospitals at the rate of at least $100 million a year. The decline came as costs continued to rise. In 1997, annual payments on the Allegheny system’s bond debt alone totaled $91 million, a chunk of which was added in June 1996 when the organization issued $365 million of bonds for its Philadelphia hospitals and medical school. Costs were rising in other areas, too. For example, Allegheny’s strategy of buying primary care physicians to funnel more patients to its hospitals was failing miserably. Losses at the medical practices subsidiary would swell to $60 million in the 12 months ended June 1997, and continued to mount into 1998. It’s not hard to understand why. Allegheny may have owned the practices, but the doctors legally couldn’t be forced to refer all their patients to Allegheny hospitals for high-priced specialty care. Many had long-standing relationships with other Philadelphia hospitals, and their loyalties lay there. Many of their patients preferred other hospitals as well. Moreover, like other hospital companies snapping up practices, Allegheny overpaid. It sometimes offered doctors guaranteed salaries and even raises, and the price of the buyouts often represented twice what the clinics were generating in revenue in a year. It hoped to make up the costs by squeezing expenses and luring more customers, and by including performance standards for the doctors. But those performance clauses didn’t appear to be worth much. Allegheny, like other hospital companies across the country, wanted doctors and was in a buying frenzy — and the doctors knew it. So, after working all hours to make their businesses go and then selling them to Allegheny, some worked less, not more, causing a decline, not an increase, in office revenue. And Allegheny’s expectations for making the offices more efficient proved wildly optimistic. Take its centralized billing system. Doctors at clinics that were bought say Allegheny insisted that it handle the billing. Yet it often was slow to bill clients, and did a poor job at going after insurers for payments on small claims. Never mind that small claims make up the bulk of a clinic’s business. Allegheny’s billing system was geared toward the big bills hospitals try to collect; it couldn’t be bothered with what must have seemed like nickel-and-dime stuff. "If they had a $100 bill denied, the hospital didn’t follow up,’’ said Joseph Calhoun, a partner in a North Hills primary care practice, Pine Richland Medical Associates, which Allegheny General opened in 1993. Adding to its problems was what proved to be a deadly third rail in Allegheny’s desire to be a full-range player in the health care business: insurance. It didn’t actually provide insurance, but it did contract with HealthAmerica and U.S. Healthcare in Pittsburgh and Philadelphia to provide medical services to 500,000 of their managed-care clients at a price equal to roughly 80 percent of the premiums the insurers collected. At the time, in late 1996, Allegheny felt it could provide the care for that price — the insurers kept the remaining 20 percent to cover the accounting and other administrative functions that they still provided. But far from making money, the so-called shared-risk contracts were money losers. HealthAmerica alone contends Allegheny owes it more than $100 million. In some cases, the managed-care patients balked at going to Allegheny hospitals, forcing Allegheny to pay unaffiliated hospitals for care even though it had no control over their costs. Even when patients came to its hospitals, Allegheny had trouble controlling costs. Its "mean administrative cost per adjusted discharge," a common benchmark used to measure hospital overhead, was an estimated $720, a third higher than the norm for Pennsylvania hospitals It’s not that surprising. Allegheny relished being a big spender well before it marched on Philadelphia, and in Philadelphia it spent even more freely, dangling big bucks in front of hospitals, doctors and medical researchers.
Stories are legion about management retreats at Rolling Rock Country Club in Ligonier, Nemacolin Woodlands near Uniontown, and Camp AHERF, the nickname given to an educational seminar held every six months or so at a North Carolina resort formerly owned by tobacco baron R.J. Reynolds. Fat car allowances and regular golf outings at exclusive clubs were showered on top administrators and doctors. Executive and committee meetings were common at Pittsburgh’s private, and pricey, Duquesne Club, the traditional home-away-from-home for the region’s captains of industry. And though they were working trips, quarterly meetings in places like Amsterdam, Paris and Reykjavik, Iceland, made the Cayman Islands insurance venture seem extravagant. Never mind that, by law, the offshore subsidiary was barred from holding meetings on the mainland, or that other hospital systems, including UPMC Health System, had similar operations to save on malpractice premiums. It just didn’t look good. Then there was the pay. Allegheny administrators and star doctors earned top dollar, and were unapologetic about it. In 1997 alone, the base pay of 26 senior administrators averaged more than $350,000, almost as much as the median for CEOs of large not-for-profit health care companies surveyed by the benefits consulting concern Hay Group. At $1.17 million, Abdelhak’s compensation package almost tripled the $393,000 reported by his counterpart at UPMC Health System, Jeffrey Romoff. The cost of all those perks and pay were exacerbated by a health care system that, by most any measure, was bloated. Almost from the beginning, bureaucracy and Allegheny went hand in hand. Even in the mid-1980s, when it was just Allegheny General and a few subsidiary organizations, there were four different boards and three dozen directors. But by mid-1997, the Allegheny system had ballooned to 10 separate boards, 55 different legal entities, 132 directors, 117 senior managers and a parent organization with nearly 2,000 employees. A common joke was that the Allegheny system had more vice presidents than most major Wall Street banks. There was little overlap on the boards, and directors say they never were sure what was going on elsewhere in the empire — each was under orders to focus on his or her own part of the world, largely out of the design of Abdelhak and his inner circle. It wouldn’t do to have too much meddling in the organization’s affairs; carving it up into a bunch of groups helped get around that problem. "It was divide and conquer,’’ a former director says. By late 1997, however, even the parent board could tell something was amiss. Money was running short, and the environment for health care wasn’t improving any. In fact, it was getting worse; insurers were demanding more discounts, and the government was tightening more. Tired of watching Allegheny stretch out bill payments, vendors began asking for money up front. Members of the parent board were uncovering sizable loans and fund transfers that they did not recall approving. And Abdelhak was growing increasingly defensive, blaming his managers for questionable actions. The patient — the Allegheny health system — was critical. Pretty soon it would be Code Blue.
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