Sentara CEO David Bernd took vertical integration one logical step at a time. Photo by Mark Rhodes

Vertical Leap
Hospital ownership of HMOs and physician practices seemed like a slam dunk, but some integrated health systems are backing away from the strategy.

By MARJOLIJN  BIJLEFELD

Rome was not built in a day, and neither was Sentara Health System's dominance in the Hampton Roads area. Often pointed to as the most comprehensive health care delivery system in the state, Sentara began its integration strategy 20 years ago, says CEO David Bernd.

"We began to put it in place because we felt the industry was going to change and because of the particular vulnerabilities of Norfolk General Hospital," he says, noting that the hospital had a more complex case mix and received no direct subsidy for indigent care. "To keep it on the leading edge, we put together a strategic plan to enhance its position, make it more competitive and ensure its survival."

In 1984, the health system established the first HMO in Virginia in Hampton Roads. It also began to develop and acquire primary-care physician practices, nursing homes and outpatient clinics. "We began to diversify out of just being an inpatient institution only."

Sentara is one of Virginia's best examples of successful vertical integration in the health care field. Not long ago, industry insiders predicted vertical integration would sweep the marketplace. It was seen as a way to increase economies of scale while promoting greater continuity of care. But for all its conceptual advantages, vertical integration has not been the answer for everyone. In the past half decade, several of the state's health care systems have made major changes to their vertical-integration strategies.

Think of the health care dollar as a piece of pie. At the table, all demanding their share, are the many parties involved in the care of each patient — the primary-care physician, specialist, hospital, home health agency and insurance company. What if all the people at the table were on the same team? Wouldn't the division of that dollar be more equitable, or at least better controlled? That was the concept.

But the application of the idea was more complicated. While all the components of a vertically integrated system revolve around health care delivery, each is a unique business. Running a hospital is not like running a physician's office, and neither of those has much in common with running an insurance company. So bringing everyone together is difficult.

For example, this summer Loudoun Healthcare endured a highly publicized airing of its financial losses, which were caused in part by its acquisition of physician practices.

All around the state, health systems have struggled to develop the right mix of vertical integration and virtual integration — a partnership that produces synergy without the capital outlay of an acquisition.

Earlier this decade, conventional wisdom was that vertical integration would be the premier model. But the Sentara formula was not easy for other hospital systems to replicate. Their mix of patient loads, reimbursement arrangements, geographic considerations and competitive pressures was too diverse to fit into any single formula.

Vertical integration, however, still has its share of believers, including Larry Sartoris, president of the Virginia Hospital & Healthcare Association. "I still think the strategy is correct if it can be executed properly," he insists. "It is a way to systematize the delivery of health care, to put all the necessary puzzle pieces together in a logical and efficient fashion. When you do that, you begin to turn the system toward one of health improvement, not just sick care. That's the theory. Pulling it off is more difficult."

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Danville Regional Hospital was up against the wall. The area it served simply didn't have enough primary-care physicians. Specialists were continuing to see patients long after they should have been sent back to their primary-care doctors because there were no other physicians to pick up the slack.

"Being the only acute-care facility in our community causes us to view the community's needs a little differently than if we were in a multihospital community," says Larry DePriest, president of Danville Regional Health System. "We're the largest resource, and with that comes the responsibility of helping the community get what it needs."

In 1995, one of Danville's few primary-care physicians moved away, and it seemed unlikely his partners could hire a replacement at a salary they could afford. That meant there would be an even greater pinch on the existing primary-care physicians. Hospital representatives met with Danville's physicians to look for a solution.

But the physician practices were unable to step up their recruiting. Primary-care physicians were in demand everywhere, and candidates were commanding high salaries. So the hospital decided to purchase the practice and give it the resources it needed to expand. Today, the health system employs eight primary-care physicians in eight offices. This summer, Danville Regional used the same strategy to increase the number of pediatricians in the area.

The hospital didn't particularly want to own the medical practices, but physicians fresh out of medical school don't seem to be as interested in owning their own practices as their predecessors had been. And if the physicians ever want to buy back the practices, DePriest would jump at the chance to let them. "I don't expect we'll ever make money off a physician practice," he says. "The physicians earn the money, and that's the way it should be."

Don't expect Danville Regional to plunge further into a vertical integration model. "We're a small market," DePriest says. "Economics don't allow an organization of our size to be in the insurance business. All that we're attempting to do is to have a sufficient supply of providers and work together."

That's how it started at Roanoke-based Carilion Health Care, which covers the wide region from Galax to Strasburg to Martinsville. Carilion got into physician practice ownership big time when it purchased Blue Ridge Primary Care, a group of about 80 physicians. The hospital system already employed about 50 physicians by then, and it now has about 160 primary-care physicians on the payroll.

Just as in Danville, the health system felt it needed to secure a supply of primary-care physicians, says Don Lorton, a Carilion executive vice president. It takes money to recruit good physicians and to upgrade facilities, and those two goals often go together.

In Martinsville, for example, Carilion is consolidating five practice locations into one new facility that will be large enough to accommodate two more doctors plus lab equipment. For patients, the improvement will be immediate. Lab work and X-rays will be done on site, and it will be easier to recruit physicians to work in this new facility. "We're certainly not making money off primary care," Lorton says. But "our organization's mission is to improve the health of the communities we serve. It gives me a little heartburn at times, but it's the right thing to do."

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Fairfax-based Inova Health System's vertical integration pattern mirrored Sentara's until it ditched its HMO. Because of rising drug costs and the changes in Medicare, Medicaid and managed-care reimbursements, "there was no prospect but to lose money [with the HMO]," says Inova CEO Knox Singleton.

The 1997 federal balanced budget act still has Virginia hospitals and health systems reeling because it reduced payments to state facilities by an estimated $1.6 billion over five years. "That's enough to eat up all the margins of everybody in Virginia," says Sartoris at the hospital association. "And it comes at a time when the private sector is being far less generous in terms of a willingness to pay for health services."

Tighter margins make it difficult for hospitals to take on additional risk, and operating an HMO is nothing but risk. "It is unlikely that many provider groups are going to have the scale or requisite capital to keep competitive for the global risk sharing that goes with individual populations, primarily because you can't control the adverse selection," Singleton says. In other words, a few people who require intense treatment can break the bank.

Inova hasn't backed away from other aspects of vertical integration, however. The company has about 100 primary-care practices, but it doesn't plan to acquire any specialty-care groups . That's because vertical integration isn't about having the most components, but about having the most logical ones. Partnerships with specialists give Inova the best of both worlds, Singleton says.

As part of the team, whether employed by Inova or not, specialists don't have to duplicate tests or lab work. Patient data is shared, and "they're all working off a single game plan." That's "virtual" integration, Singleton says. "There are two basic underlying dynamics. The fewer boundaries you create within the process that's being managed, the greater the overall level of quality and efficiency. Secondly, you only improve the process by giving everybody access to the data and performance information." Inova has developed its own management system designed to allow this type of data mining.

"Systems are most effective when they have a mixture of virtual and vertical integration," Singleton insists. "Having home health integrated right into the system is a huge advantage. On the other hand, individual specialty physician groups are much more powerful under virtual integration."

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Riverside Health System and Trigon Healthcare decided to join forces so they wouldn't have to reinvent the stethoscope.

Riverside knew hospitals. Trigon knew insurance. So the two formed Peninsula Health Care with Trigon owning 51 percent and Riverside owning 49 percent. Representatives of both companies sit on the HMO's board, and Burke King serves as its president.

The joint venture allows Riverside and Trigon to focus on their specialties while benefiting from each other's expertise. Case in point: disease management — a well-developed set of protocols for treatment of chronic illnesses, such as diabetes. "In conjunction with Riverside, we have educational classes for diabetics on diet issues," King says. "Riverside employs an ophthalmology group that can do the retinal eye exams to catch and treat diabetic retinopathy early." Peninsula Health Care recently completed a successful pilot program that placed diabetic patients in a wellness program that emphasized the role of diet and exercise in controlling blood-sugar levels.

The program helped everyone: The patients gained better control over the disease; the hospital got involved beyond simply caring for sick patients, and the insurance company improved its preventive care record.

Similarly, Peninsula Health Care runs an immunization project in which it sends a van out into the communities to help immunize children. Trigon can send its members to the van, but that's not to say that all Riverside patients are Trigon enrollees, or that all Trigon enrollees are admitted to Riverside. But each has a stake in the success of the other.

"Riverside contracts with other payers, but here they have the ability to make a profit on the health plan because they own it," King says. "They have an incentive to grow the health plan. And our enrollees are more likely to be admitted to Riverside [because they would otherwise pay higher, out-of-network fees.]" And Peninsula Health Care has been able to maintain profitability and increase its market share by offering competitive premiums.

The plan has worked well enough to be worth replicating. King also serves as president of Priority Health Care in Virginia Beach. That's a partnership originally created with Tidewater Health Care, which was acquired later by Sentara. It's too early to tell how this partnership will fare, but its evolution clearly shows that the boundaries of health care integration — both horizontal and vertical — are beginning to overlap.

With the dynamics of health care being what they are, the only certainty is that none of these models are static.