Orthopaedic. January/February Product News

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1 Orthopaedic January/February 2007 Product News

Should You Develop an Ambulatory Surgery Center or Hospital?

There are also 133 specialty surgical hospitals, of which 15 percent are categorized as orthopaedic hospitals according to the American Hospital Association and The Lewin Group.

This article will examine the benefits of both opportunities with a review of the process, investment, risks and potential for return on investment. commercial payers.

Ambulatory Surgery Centers As one panelist noted in a report by the Federal Trade Commission and the Department of Justice (Improving Health Care: A Dose of Competition - July 2004), ASCs are a

2 Should You Develop an Ambulatory Surgery Center or Hospital? Weighing the Pros and Cons Author: Kenneth Hancock According to Medicare, 4,506 certified ambulatory surgery centers (ASCs) currently operate in the U.S. Of these, ten percent are orthopaedic-focused. There are also 133 specialty surgical hospitals, of which 15 percent are categorized as orthopaedic hospitals according to the American Hospital Association and The Lewin Group. (Source: Goldman Sachs, Healthcare Services: Facilities U.S., 2005) Over the course of the last ten years, many orthopaedic groups have developed their own surgery centers and some have developed their own surgical hospitals. This article will examine the benefits of both opportunities with a review of the process, investment, risks and potential for return on investment. commercial payers. The number of Medicare-certified ASCs has grown at an average annual rate of 8.3 percent from 1999 to (Source: InforMed Healthcare Media, LLC, 2006) Exhibit 2 illustrates the growth of ASCs. Ambulatory Surgery Centers As one panelist noted in a report by the Federal Trade Commission and the Department of Justice (Improving Health Care: A Dose of Competition - July 2004), ASCs are a common-sense, intelligent response to a mature health care delivery system and industry gripped by inefficiencies and to health care spending being out of control. Exhibit 1 shows the U.S. trend toward outpatient surgeries. Exhibit 2. ASC Metrics: 1999 to 2006 The Perfect Storm Physicians, Patients and Payers Prefer the ASC Model ASCs benefit physicians, patients and payers. Where else in healthcare can that be said? Numerous factors continue to shape the evolution of outpatient surgical facilities, including: Physicians ASCs cater to physicians demands by providing efficient and flexible scheduling, focused staff and enhanced productivity in a premier work environment. By focusing on productivity and efficiency, ASCs can achieve faster turnaround time between cases, enabling physicians to perform more surgeries in a defined period of time. Considering that physician incomes remain under pressure from declining reimbursement and malpractice costs, equity participation in ASCs presents an attractive opportunity to enhance incomes. An efficiently managed surgery center will provide an excellent return on investment. Exhibit 1. Surgical Trends in the U.S.: 1981 to 2007P According to the Federated Ambulatory Surgery Association (FASA), currently 83 percent of all surgeries performed are done on an outpatient basis on over 12 million patients a year in the 4,500 ASCs. These procedures have saved billions of dollars for governmental and Patients Patients enjoy the less institutionalized setting and specialized care provided at ASCs. Typically, ASCs are more conveniently located than general acute care hospitals and offer simplified admission and discharge procedures in a highly personalized setting. continued on page 3 2Orthopaedic Product News January/February 2007

3 continued from page 2 Payers Interest in ASCs has grown as managed care organizations have sought a cost-effective alternative to inpatient services. ASCs can provide more competitive pricing to commercial payers which is inherent in the model s lower cost structure. Freestanding ASCs saved Medicare approximately $1.1 billion in 2005 over hospital-based ASCs. (Source: The Moran Company Study Conducted for the Federated Ambulatory Surgery Association) Essential factors that drive the model include: Physician Equity Participation Physicians currently performing surgical cases in a hospital inpatient or outpatient setting are potentially losing on all fronts. Not only is the environment less efficient, stifling their productivity, but they don t have ownership in the business. With declining incomes and a litigious society, physicians must take control of their surgical environment, which includes ownership of the business. According to FASA, some level of physician ownership exists in more than 90 percent of ASCs in the U.S. (See Exhibit 3.) Technology Improvements in surgical technology and anesthetic agents allow surgical procedures to be performed in less acute settings and have significantly expanded the types of surgical procedures that can be performed in ASCs. ASC Ownership Structure No Physician Ownership 10% ASCs With ASCs Physician With Physician Ownership Ownerhip Phys / Hosp 18% Phys / Corp / Hosp 2% Lower Cost Ambulatory surgery performed at a free-standing ASC is generally less expensive than hospital-based ambulatory surgery for a number of reasons, including, lower facility development costs, more efficient staffing and space utilization, and a specialized operating environment focused on cost containment. Procedures performed in an ASC generally cost between 30 to 60 percent less than the same procedures performed in a hospital setting. (Source: Informed Healthcare Media, LLC, 2006) Physician Ownership 90% Phys / Corp 12% Exhibit 3. ASC Ownership Metrics Physician Only 68% Minimally Invasive Surgical Techniques The race is on for medical device companies to develop minimally invasive surgical implants, instruments and surgical techniques in all subspecialty surgeries. Significant technological advancements are emerging in orthopaedic, spine and total joint procedures as well as neurosurgery, cardiology and gastroenterology. Demographics The aging of the 79 million Baby Boomers creates significant growth in the over 55 segment of the U.S. population and will be a driving force in the demand for outpatient surgical services. Cost to Build an ASC The cost to develop a new ASC is approximately $1 million per operating room. Costs for a small single specialty center with two surgical suites range from $2 to $ 3 million and $4 to $8 million for a larger multispecialty ASC. Typically, the majority of the costs associated with development, including the tenant improvement construction cost and surgical equipment, can be leveraged by debt. The need for equity is isolated to working capital, which is typically four to seven months of operating expenses totaling $750,000 to $1 million. Raising capital between physician partners and corporate partners is relatively easy to accomplish. The investment ranges from $7,500 to $15,000 for a 1 percent interest in the partnership plus assumption of pro-rata debt dependent on debt structure. Business Opportunity Types of Ownership Physicians may own the ASC entirely or may partner with a hospital and/or corporation in some combination. Positives and negatives are present for both approaches. All Physician Physicians are busy being physicians and their administrators are busy running practices, so who develops and operates the surgery center? Many times, physicians will hire consultants to navigate its development and initial setup. Once the center is operational, however, consultants move on, leaving the surgery center to run itself. As with all businesses, ASCs typically don t run well without dedicated management. Hospital and Physician The overarching benefit of this model is that you have a partner with whom to share the risk. Typically, the community hospital has capital and the ability to secure insurance contracts at attractive rates. The challenge to this model is the trust factor that is, many physicians simply don t trust hospital management. At the same time, physicians have diluted ownership by bringing on a hospital partner. Most hospitals desire a structure that allows the hospital to maintain a majority ownership in the surgery center. According to 2004 data, hospitals have ownership interest in 21 percent of all ASCs. (Source: 2004 ASC Salary and Benefits Survey, Federated Ambulatory Surgery Association, 2004) According to our research from a variety of industry sources, the average multi-specialty ASC has approximately 12 physician partners, each with approximately three percent ownership, and generates approximately $4 million in net revenue and $1.2 million in EBITDA. Ownership per physician tends to increase in a single specialty ASC. Corporation and Physician Approximately 30 companies are in the business of partnering with physicians to develop, own and manage surgery centers. Of the 4,500 Medicare-certified U.S. ASCs, only 837 facilities (less than 20 percent) are owned and managed by multi-facility chains. (Source: Informed Healthcare Media, LLC 2006) In this model, physicians benefit from having a strong capital partner to ensure that their return on investment is based on the success of an excellent plan and well-run business. continued on page 4 January/February 2007 Orthopaedic Product News 3

continued from page 3 The corporate partner has experience in budgeting, financial analysis, human resources, technology, clinical benchmarking and marketing.

4 continued from page 3 The corporate partner has experience in budgeting, financial analysis, human resources, technology, clinical benchmarking and marketing. This allows the physicians to focus on surgery and the corporate partner to focus on business. Aligned incentives of ownership work well in many partnerships. The risks inherent to this model are intense competition from local hospital systems and strained relationships with hospital administration once the surgical cases move to the ASC. Three-Way Partnership Popularized by United Surgical Partners International and the Baylor Health Care System, this model combines the interests of physicians, hospital and a corporate partner. The benefit of this model is that the two parties that typically don t trust each other now have a third independent partner to operate the business in the best interest of all partners. This model eliminates tension between the physicians and hospital, adds a strong capital partner and provides the ASC with insurance contracts. Meanwhile, the day-to-day operations are driven by an independent corporate partner and access to hospital volumes is strong. The caveat is that the hospital must have evolved its strategy to the point that allows such a joint venture; otherwise, physicians will waste significant time trying to assemble this type of partnership. Specialty Surgical Hospitals (SSHs) Specialty surgical hospitals offer both inpatient and outpatient services for a specific specialty (e.g., cardiac, orthopaedic or psychiatric) or type of patient (e.g., children or women). The facilities and care are tailored to meet the needs of the specific condition, patient or procedure on which the SSH is focused. Specialized care is not necessarily a new development in the surgical facilities industry, as pediatric and psychiatric hospitals have existed for years. More recently, however, a number of cardiac, orthopaedic and surgical hospitals have been or are being built. There are still relatively few SSHs, but the number has tripled from 31 in 1997 to 133 in 2004, as Exhibit 4 shows. These specialty hospital facilities combine the best features of an ASC, including accessible location and layout, adherence to scheduling, convenience for patients and physicians, less expensive, focused on a limited set of surgical procedures, short stays and potential for physician ownership. Physicians relish the opportunity provided by SSHs. The SSH offers a chance to improve the delivery of care by redesigning the process and creating a more efficient and effective system. The model is a consumerfriendly response to the desire for convenient access, enhanced customer service and state of the art designs with the efficient operations consistent with an outpatient surgical facility. SSHs are emerging as the facility of choice by physicians, patients and payers for cases that require stays up to 72 hours. According to MedPac s August 2006 Final Report to Congress, these surgery-only facilities maintain 14 or fewer beds and house minor and complex outpatient procedures including neurosurgical, spinal and total joint replacements. Larger than ASCs, these facilities provide a greater range of services such as diagnostic imaging, pharmacy, laboratory, dietary services and rehabilitation. Final Report to Congress Specialty Hospitals As a part of the Medicare Modernization Act of 2003, Congress placed an 18 month moratorium on physician investment and referrals to specialty hospitals for facilities in operation after November 18, 2003, reflecting sensitivity over potential physician self-referral issues. The moratorium expired on June 8, 2005, but the Centers for Medicare and Medicaid Services delayed the review of any new license until August MedPac was commissioned to study the impact of the SSH on community-based hospitals and issued an initial report in September 2004, with a final report August The moratorium was lifted in August Currently there is no restriction on physician ownership in specialty hospitals. Clinical Results As reported recently in three publications, clinical results rate high in specialty hospitals. Sioux City Journal, Dakota Dunes, South Dakota, October 17, 2006 According to HealthGrades, the industry s leading ratings company (2007 ratings), Siouxland Surgical Center is the only hospital in South Dakota ranked in the top ten percent of all hospitals nationally and number one in South Dakota for spinal surgery. Siouxland is a 20-bed licensed SSH. Columbus Business First, Columbus, Ohio, November 24, 2006 New Albany Surgical Hospital reports that the hospital is one of 14 inpatient facilities in the nation to receive the Summit Award from Press Ganey Associates, Inc., a South Bend, Indiana, company that helps health care facilities measure and improve patient satisfaction. Summit awards go to hospitals ranked in the 95th percentile for patient satisfaction for at least three straight years in Press Ganey s 1,600-hospital database. New Albany is a 42-bed orthopaedic surgical hospital. Exhibit 4. Specialty Surgical Hospital Growth: 1997 to 2004 The emergence of SSHs is in response to a demand created from frustration with general acute care hospitals that are perceived as unresponsive to the desires of physicians and patients. Many of the same market and environmental factors that have driven the growth of the ASCs have also encouraged the recent development of specialty surgical hospitals. Aberdeen News, Dakota Plains, South Dakota, October 17, 2006 According to a study released by HealthGrades, Dakota Plains Surgical Center is the number one provider of joint replacement surgery in South Dakota. In addition, the center was ranked among the top five percent in the nation in total hip and total knee replacecontinued on page 5 4Orthopaedic Product News January/February 2007

continued from page 4 ment and was given a five-star rating the highest award for clinical quality outcomes for the fifth year in a row. Dakota Plains is an eight-bed hospital.

5 continued from page 4 ment and was given a five-star rating the highest award for clinical quality outcomes for the fifth year in a row. Dakota Plains is an eight-bed hospital. Comparison of Alternatives Exhibit 5 shows a comparison of alternatives that must be considered when deciding between an ASC and SSH, compared to the traditional hospital model. Exhibit 7. Comparison of ASC and SSH Models Project Scope Drives Cost and Cost Drives Investment Some critical points to consider related to the cost of a project and the investment required include: Surgical Case Volume Inpatient and outpatient case mix what is the net case count? This information is critical in the planning process, as it determines the net revenue the business will generate plus the scale of the facility needed to accommodate the surgical cases. Exhibit 5. Site of Care Comparisons Some key statistics for orthopaedic and surgical hospitals appear in Exhibit 6. Number of Hospitals Average Number of Beds Annual Admissions Occupancy Inpatient Charges Medicare Share Medicaid Share Average Initial Investment Per Physician Average Number of Investors Average Ownership Share Per Physician Average Aggregate Physician Ownership Return on Invested Capital Hospital Income per Physician % 32% 33% 2% $98, % 67% 34% $50,000 (Source: MedPac August 2006 Report to Congress Physician Owned Specialty Hospitals Revisited) Insurance Contracting Can the facility secure insurance contracts? If not, do you have an out-of-network strategy? The business may have a strong number of surgical cases, but if you cannot get paid for the work performed, it is a potentially devastating blow to cash collections. You must have a plan for reimbursement prior to construction of the facility. Ancillary Business Do the physicians considering the project already own MRIs, CTs, etc.? Does that need to be included in the SSH project? Don t assume that because you have implemented imaging services they will be utilized, particularly if most of the partners already have investment in MRI and related imaging services. Project Scope Be careful to not overbuild. This is perhaps the number one reason for failure. It is easy to overbuild a facility well beyond capacity, creating undue stress on the financial performance of the business. Better to under-build and expand later. Partnership Does it make sense to have separate partnerships for the real estate versus the operating entity? Consider separate partnerships for the real estate from the operating entity. The real estate provides a different investment opportunity. Exhibit 6. Specialty Hospital Metrics Cost Comparison The costs of constructing an average ASC versus a SSH are shown in Exhibit 7. While there is dramatic difference between the net revenue generated in a SSH versus an ASC, there is considerably more expense associated with constructing a SSH. Equity Be sure that enough cash is committed to the project. A common problem has been the lack of cash in the crucial start-up phase. It is easy to miscalculate the cash needs and be forced to initiate capital calls from the partnership to meet cash needs in the first 12 months of the project. continued on page 6 January/February 2007 Orthopaedic Product News 5

Conclusion continued from page 5 Debt Be sure you have a commitment for financing prior to starting the project.

The number of ASCs continues to grow as a result of the demand by the key participants in the industry physicians, patients and payers.

Technology continues to improve the prospects for shifting more surgical procedures to an ASC setting.

6 Conclusion continued from page 5 Debt Be sure you have a commitment for financing prior to starting the project. Rates may vary between sources so, shop the financing among numerous financial institutions. The basic steps required in the planning process are illustrated in Exhibit 8. The number of ASCs continues to grow as a result of the demand by the key participants in the industry physicians, patients and payers. The high levels of patient satisfaction, physician efficiency and lower costs are all associated with this innovative model. Technology continues to improve the prospects for shifting more surgical procedures to an ASC setting. Physicians have led development of ASCs and are currently leading development of SSHs for exactly the same reasons. Both settings provide physicians with control over their surgical environment, which mitigates the daily frustrations of working in an inefficient environment. Planned and implemented properly, the surgical facility provides the physician, patient and payer a model that changes the game for the betterment of health care. Kenneth Hancock is Co-founder, President and Chief Development Officer of Meridian Surgical Partners. Meridian, located in Nashville, Tennessee, is a surgical facilities company focused on acquisitions, development and management of physician-owned surgical facilities. He can be reached at khancock@meridiansurg.com. Exhibit 8. The Project Planning Process Questions That Need Answers - The Decision Tree How does a physician decide what type of facility is in her best interest? Obviously, many factors should be considered; however, the driving factor is always centered on the number of surgical cases and associated case mix. Exhibit 9 examines a series of questions that lead to an appropriate decision of what type facility is the best fit. Meridian Surgical Partners 5141 Virginia Way, Suite 420 Brentwood, TN Phone: (615) Fax: (615) Excerpted from January/February 2007 Issue of U.S. Orthopaedic Product News, and used with the permission of Knowledge Enterprises, Inc. Exhibit 9. The Decisionmaking Process 6 Orthopaedic Product News January/February 2007 Knowledge Enterprises, Inc. 147 Bell Street, Suite 303 Chagrin Falls, Ohio USA fax knowledge@orthoworld.com

What s Wrong with Healthcare?

What s Wrong with Healthcare? Dan Murrey, MD, MPP Chief Executive Officer Agenda What s wrong with healthcare in the US? What would make it better? How can you help? What s wrong with US healthcare? What