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Perspectives

The “For-Benefit” Academic Medical Center

A Solution for Survival

Sabeti, Heerad; Kahn, Marc J. MD, MBA; Sachs, Benjamin P. MB, BS, DPH

Author Information
doi: 10.1097/ACM.0000000000000583
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Abstract

Academic medical centers (AMCs) are the backbone of our health care system. In 2012, the United States spent 17.9% of its gross domestic product on health care, with AMCs accounting for approximately 20% of these expenditures ($540 billion).1,2 AMCs have a broad mandate: They strive to provide high-quality, cutting-edge care, advance medical knowledge, and educate the next generation of physicians, nurses, and allied health care professionals. In addition, AMCs deliver 40% of charity care in the United States, even though they account for only 6% of all hospitals.3 Although appreciated by the public, the tripartite mission of AMCs often results in a higher cost structure.

Many AMCs are facing a perfect storm of challenges that threaten their viability. A 2014 report from the Association of American Medical Colleges (AAMC) describing the important role that AMCs play stated that “tectonic forces are causing upheaval in health care; AMCs must evolve rapidly or risk becoming high-priced, anachronistic institutions in a landscape of highly organized health systems.”4 The Affordable Care Act and payment reforms are forcing physicians and hospitals to provide higher-quality care at significantly lower cost. AMCs also are contending with dwindling research dollars, the high cost of undergraduate medical education, and unfunded residency positions that they need to support. Furthermore, safety net hospitals, the majority of which are AMCs, will receive $18.1 billion less in Disproportionate Share Hospital funding between fiscal years 2014 and 2020—revenues that may not be replaced by Medicaid expansion.5

In response to these fiscal challenges, AMCs need to improve management, maximize efficiency, and improve quality. However, these changes may not be enough. The 2014 AAMC report suggests that AMCs have four options: “form a system (if they have capital and wherewithal to do so), partner with others in a collaborative network model, merge into a system, or be prepared to shrink in isolation.”4

Merging Into an Existing System

Acquisition by a for-profit (FP) hospital company is an option many AMCs are considering. In recent years, FP hospital companies have expanded nationally, often purchasing financially distressed hospitals that are in need of capital investments. Depending on their ability to issue new stock and raise debt, FP hospitals can have better access to capital through private investments, a solution not available to not-for-profit (NFP) hospitals. For a number of reasons, FP hospitals generally can more easily maintain a positive operating margin than NFP hospitals. First, most FP hospitals are community hospitals with a single operational focus: clinical care. Additionally, many have stronger purchasing power because of their size. The financial pressures exerted by shareholders also make FP hospitals more adept at managing costs and efficiencies. Finally, FP hospitals manage their case- and payer mix more carefully than NFP hospitals by establishing themselves in areas with relatively well-insured patients.6

The question for AMCs is whether a new FP owner will keep their academic mission intact given their higher cost structure. An analysis conducted in 2000 of three AMCs sold to FP hospital companies did not find a major difference in missions.7 Since then, in one case, the AMC saw a marked deterioration in mission, quality, and physician and patient satisfaction.7,8 Other AMCs that were acquired by FP hospital companies have reverted to NFP hospitals.9

Forming a System: Integration

Many AMCs prefer to control their own destinies and form an integrated health system, either wholly owned or “clinically integrated.” To do so, they need to address several challenges: preserving the academic missions, integrating very different cultures, improving the quality of care, and, importantly, determining how to finance expansion.

In the United States in 2012, all 141 accredited MD-granting medical schools and approximately 98% of the 400 major teaching hospitals and health systems were NFP.10 As NFP AMCs, they do not pay local, state, or federal income taxes because they function like a charity expected to provide community benefits. According to a Government Accountability Office report, NFP hospitals received almost $13 billion in tax benefits in 2002.11 Advocates of NFP hospitals claim that their mission is to improve their communities, whereas FP hospitals aim to maximize shareholder value. However, this claim has been hard to prove, and the Internal Revenue Service has instituted new requirements for reporting under the Affordable Care Act to substantiate the community benefits provided by NFP hospitals.12

Forming a large integrated health system requires significant capital; doing so may cost, for wholly owned systems, upwards of hundreds of millions of dollars.4 These costs include the acquisition of hospitals and physician practices, the implementation of advanced information technologies to provide population-based health care, and the ability to accept shared risk contracts.4 As a result, many AMCs who choose the path of integration need to find new sources of capital. Because of their tax-exempt status, their current sources of capital are limited to already-slim operating margins, tax-exempt debt, technology transfer/license agreements, and tax-deductible philanthropy. U.S. corporate and tax laws place limits on the ability of NFP hospitals both to use their income or assets to benefit private parties and to freely enter into joint ventures and partnerships with FP entities. These constraints make it extremely difficult for most AMCs to raise the capital they need and to be agile enough to undertake integration.

The For-Benefit AMC

One potential solution to overcoming the challenges associated with integration is for an AMC to convert from an NFP entity to a for-benefit (FB) one—an emerging new class of organizations that are drawing considerable attention from policy makers.13–15

Combining aspects of FP and NFP entities, FB organizations have two principal characteristics: (1) their primary commitment is to a social purpose, and (2) they generate a substantial portion of their income through business activities. As such, FB entities are able to issue stock and bonds that provide investor value. Some also have secondary characteristics, such as standards for fair compensation, stakeholder governance, and safeguards on the use of assets. Spanning many industries and geographies, FB organizations constitute an emerging fourth sector of the economy (the three traditional sectors being FP, government, and NFP) that has been growing rapidly as the ranks of socially and environmentally motivated entrepreneurs, investors, and consumers have increased over the past several decades. In fact, a 2013 report suggests that companies that have a social benefit outperformed the Standard & Poor 500 index by a factor of 10.16

Despite their successes and potential, FB organizations have been going against the grain of established legal and market systems, which have historically been designed to accommodate only FP and NFP forms. As a result, many FB entities have had to adapt creative—though often cumbersome—organizational structures to preserve their commitment to their mission and values, even as they scale their commercial footprint. Examples of successful FB organizations range from Goodwill Industries, which fuels its employment and training programs with 2,700 retail stores and $4.9 billion in earned revenues, to diversified food products brand Newman’s Own, which donates all its profits to charity (over $400 million since its founding), to the publicly traded Danish pharmaceutical Novo Nordisk, worth $7 billion, which was founded with the mission to “defeat diabetes.”17

For many aspiring FB entities, however, it has been too difficult to overcome the myriad challenges associated with developing in a system that only supports FP and NFP organizations. Recognizing these challenges and the fourth sector’s potential for addressing a broad array of societal problems, national, state, and local governments have begun enacting new policies and initiatives to define FB organizations, remove the structural barriers they face, and accelerate their growth. In recent years, for example, about 26 U.S. states have created new FB corporate entities, including flexible purpose corporations, benefit corporations, and low-profit limited liability companies. States and municipalities also have launched economic development initiatives focused on growing FB enterprises, and procurement and contracting policies have been expanded to recognize FB organizations.

One prominent example of a new policy aimed at harnessing the potential of FB entities—which could serve as potential guidance for AMCs—arose out of the central tension faced by health care reform. In 2009, when it became apparent that the debate between the “public option” and private insurance could not be resolved, a bipartisan group of lawmakers came up with a compromise provision in the Affordable Care Act to create a new class of FB health insurance entities, called Consumer Operated and Oriented Plans (CO-OPs).18 CO-OPs were created to be “private, consumer-governed health plans designed to serve the social purpose of furthering the well-being of their members … their profits must be directed toward improving benefits, enhancing quality of care, reducing premiums, or otherwise advancing their mission.”13,19 A new section of the tax code, IRC 501(c)(29), was created to provide CO-OPs with exemption from federal taxation. So long as it does not compromise their mission, CO-OPs are allowed the flexibility to incorporate as, or convert to, one of these new FB corporate entities being created by various states and to access private capital for expansion. Since the legislation was enacted, CO-OP insurers have been created in 23 states; they are offering coverage on the insurance exchanges and have attained about 20% of enrollment.20

Although the concept of an FB health insurance entity could potentially have been implemented in some states under existing law—albeit with some creative and expensive legal maneuvering—this legislative approach allowed for these entities to be created in all states in a systematic way with relatively lower transaction costs and reduced regulatory barriers, while also developing a framework for government support and oversight to ensure their viability and accountability.

For AMCs considering integration, leveraging the FB model could provide a pathway around the restrictions they face as NFP organizations—allowing them flexibility and access to private capital while preserving their mission. To pursue the FB pathway, AMCs have two options. The first is for a given AMC to work within the constraints of existing laws and its unique circumstances to restructure itself as an FB. The second would be a “clean sheet” legislative approach similar to how the CO-OPs were developed, with a new FB AMC model created under federal law, allowing for the orderly conversion of NFP AMCs. The former approach would be a one-off solution that requires a fair amount of creativity, cost, and compromise, but it is a more immediate solution for AMCs in peril. The legislative approach has its own costs and uncertainties but would be the optimal way to create a robust and streamlined model that could help all AMCs interested in converting to an FB structure.

Whichever approach is pursued, the first step must be the development of the design criteria that an FB AMC must satisfy. What are the essential features required to ensure that an FB AMC can be financially viable and able to successfully compete in the health care marketplace without compromising its mission?

On the basis of a high-level analysis of the commonalities and variances across existing AMCs as well as the changing dynamics of the health care market and policy environments, we offer the following list of essential features of an FB AMC as a working draft to spur further analysis and discussion. It is important to note that these characteristics are interrelated and balance, limit, or reinforce each other in multiple ways; thus, they are intended to function as an inseparable set.

  1. Social purpose: The primary purpose of an FB AMC must be to improve population health by integrating three mutually reinforcing missions: providing high-quality health care to patients, advancing medical knowledge, and educating the next generation of physicians, nurses, and allied health care professionals. The organization must maintain an irrevocable commitment to this purpose, without allowing financial influences or stakeholder pressures to dilute it.
  2. Governance: FB AMCs should have an integrated governance structure that appropriately balances the interests of all stakeholders.
  3. Capital structure: FB AMCs should be able to access multiple forms of investment and philanthropic capital (including debt, equity or equity-equivalent stock, grants, bonds, etc.). Any equity or equity-like investments raised by an FB AMC must be essential to advancing its purpose, must be on concessionary terms, and must not give rise to a tax haven for the investors.
  4. Earnings (profits): Any earnings generated by an FB AMC must be used exclusively to further its purpose. Any investment in an FB AMC that has a claim on its earnings or unrestricted net assets (equity) can only accrue in proportion to the degree to which the FB AMC is achieving its purpose.
  5. Contracting: FB AMCs should have flexibility in forming partnerships, affiliations, and joint ventures with multiple types of health care and commercial entities as necessary for system expansion and commercialization of research.
  6. Transparency: FB AMCs should monitor, track, and regularly report data on costs, procedures, and outcomes to their internal and external stakeholders. Any mandatory reporting to external parties must be balanced to not unduly jeopardize the organization’s ability to compete in the marketplace.
  7. Compensation: FB AMCs should align compensation policies and incentives with clinical outcomes and cost efficiency.
  8. Assets: In the event of the dissolution or conversion of an FB AMC, any assets held by the entity, beyond those against which there is a legitimate claim by investors or other stakeholders, may only be donated, transferred, or otherwise settled in a manner that advances the FB AMC’s social purpose.
  9. Private benefit: To protect against abuse, fraud, and mission drift over the long term, FB AMCs should conform to conflict-of-interest standards and prohibitions on benefits to private persons that are at least as strong as those in place at NFP organizations.
  10. Taxation: To create a level playing field that enables FB AMCs to compete despite the inherently higher cost structure associated with their tripartite mission, they should be provided exemption from income and property taxes, so long as their social benefit is clear and measurable.

Once the design criteria for an FB AMC have been fully established, implementation of the model can begin, either at the individual AMC level or through the legislative approach described above. AMCs that choose to make the conversion from their current NFP model to the new FB model will have to navigate a range of important issues, such as regulatory compliance and transfer of municipal bond debt and charitable assets. Although these are worthy of careful examination, the details and complexities of implementation and conversion are beyond the scope of this article, which is intended only to provide a high-level introduction to the FB model as an alternative pathway for struggling AMCs.

The FB AMC, as envisioned here, embodies many of the features and advantages of the NFP model while adding certain flexibilities, such as access to private capital and the ability to pursue joint ventures and partnerships with commercial entities. This added flexibility is balanced with measures that ensure accountability and a primary commitment to mission, which would be necessary for the Internal Revenue Service and other regulatory agencies to sanction the model, as they have done with CO-OP health insurers and other FB entities.

Although conversion to an FB organization can address the structural impediments to integration, it is not a panacea. There are numerous leadership and operational challenges that will need to be overcome as well, including, importantly, an FB AMC’s ability to provide an adequate return on investment to attract the private capital it may require for integration. With effective management and operations, doing so should be achievable through a number of means, despite the higher costs that AMCs have to absorb to deliver on their missions. Although current clinical care funding models produce slim margins at best, new models of care that incorporate population management with shared savings and risk contracting can, and will, change this paradigm. Large networks enjoy economies of scale and have more purchasing power than smaller systems. Private investment supporting research can yield valuable intellectual property that can produce a return on investment through technology commercialization. As an example, Stanford University’s StartX is expected to eventually draw over $80 million through alumni investment alone.21 With respect to education, the Kaiser Permanente system and the University of California San Francisco Bridges Curriculum save money by training residents to meet their needs (i.e., to practice in an integrated health system).

FP and NFP organizations have undoubtedly been engines of both economic expansion and improved standards of living in the United States. However, they do not provide adequate flexibility for a growing number of organizations that combine the best attributes of both models. It is time to ask why AMCs must choose to advance either shareholder value or the public good. Restructuring an AMC as an FB entity may be the best way to maintain the financial viability of these critical organizations without jeopardizing their invaluable contributions to society.

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