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Alex Kacik: Hello, and welcome to Modern Healthcare’s Beyond the Byline, where we offer behind the scenes looks into our reporting. I’m Alex Kacik, senior operations reporter. Senior finance reporter Tara Bannow is joining me today to talk about CommonSpirit Health, the largest not-for-profit health system in the country behind Kaiser Permanente. Thanks for joining me, Tara.
Tara Bannow: Thanks for having me.
Alex Kacik: So Lloyd Dean is retiring in the summer of 2022, 3 years after Dignity Health merged with Catholic Health Initiatives to form CommonSpirit Health. This is a sprawling 140 hospital health system that spans over 20 states and has 33 billion in annual revenue. When you’re talking to folks who have watched him over the years lead various health systems and how CommonSpirit Health is faring, what do they say about his departure?
Tara Bannow: Yeah. And personally, I was surprised to hear this, so I kind of went into it through that lens. I thought that Lloyd was going to be the one to kind of stay and lead CommonSpirit for the long run, especially after Kevin Lofton, who was the co-CEO, retired in 2020. But, you know, I talked to a number of analysts, a number of folks who cover CommonSpirit, and they pointed out, “Look, you know, he’s 71. He’s been doing this for decades,” and, you know, capping off his career by putting together what we know was a very difficult merger and then getting CommonSpirit off the ground, getting it on what appears to be relatively stable footing, that’s all really hard to do. And it makes sense that now he wants to hand off this enterprise to a new leader.
Actually, I talked to a guy from Korn Ferry and he kind of compared it to the Advocate Aurora merger that was in 2018. So they also started out with a co-CEO model, like CommonSpirit, but this analyst said, you know, “Jim Schogsburg, he’s the CEO, he said that if Jim were to retire now, that would be surprising, because he’s in his early sixties, has a lot of career left, but 71 is a different place to be.”
Alex Kacik: Yeah. And there was a lot of anticipation. I remember you and I covered this when it was nearing completion, the CommonSpirit deal, Dignity and CHI, and I think it was our first co-byline for the magazine. There was a lot of talk about that co-CEO model and how that was going to work as the system’s integrated, you know. And what we’ve come to see now, and in most cases that’s usually like a two-year arrangement at tops and one of them steps down or retires. And, you know, like you said, I think Lloyd Dean was expected to lead it over the long haul after Kevin Lofton stepped down.
But there was other complicating issues aside from the massive scale of these two organizations, predominantly CHI, but, you know, the Vatican had to green light the merger. Whenever you have the Catholic doctrines that come into play and those directives, and you have to get these, you know, extra layers of approval and ensure, you know, what expectations are for certain types of procedures, like abortion or gender affirming care. And so, you know, you reported for the first two years, since 2019, they’ve posted some pretty significant operating losses. And since then, it sounds like over the past year or so, they’ve been able to get a better clamp down on expenses and find ways to operate in the black.
Tara Bannow: Yeah, that’s right. I think, to be fair, early credit ratings that came out suggested, you know, the agencies were writing, you know, we understand that it takes a while to get your footing as a merged entity. There’s a lot of risk involved. So the executives with CommonSpirit were talking about all these cost savings they were going to get, but initially it is a very expensive thing to do when you’re merging two systems of this size. So S&P wrote in its initial report on CommonSpirit that its finances will decline initially, and then they’ll ultimately improve. So I think that’s kind of starting to bear out. So the financial losses in the first years as a system were pretty alarming. I mean, $602 million in fiscal 2019, which was the first year as a system, and then $550 million in the subsequent year.
And that’s with more than $800 million in stimulus grants. So it would’ve been much steeper without those. And in late 2020, what was interesting on investor calls, you had analysts asking the system if it expected to violate its debt covenants, which that’s not exactly a show of confidence to have people asking you that. But yeah, I mean things have started to turn around. It’s too soon to say whether this will be permanent, but CommonSpirit did generate almost a billion in operating income in fiscal 2021, a 3% margin. Would’ve been 1% without stimulus grants. So it’s not amazing, but it’s much better than they had been doing.
Alex Kacik: So hospital executives claim that it takes at least a year or two to fully integrate. Like you were saying, there’s a lot of moving parts, you have to combine IT systems, and, you know, you manage supply chains through different operating processes and different ERP platforms. You often have different cultures when it comes to day-to-day management, especially when it comes to your physicians and whether you’re, you know, more hands on or hands off there, but ultimately they say you’ll save money through bundled purchasing, through other economies of scale. And then, you know, you have the critics on the other side of mergers saying that those efficiencies don’t often pan out, because it’s really hard to integrate large organizations, given some of the executive redundancies.
We’ve seen in various reports that efficiencies are harder to glean when organizations are spread out. It’s harder to bundle purchasing across multiple states. And that’s similar when it comes negotiations with insurers. Dignity had a more regional presence in the West, while CHI is spread out across more than a dozen states. And, you know, we talked to them a few times independently and then, you know, talked about their expansion and how they purchased dozens, hundreds of doctors over their growth. And that’s hard to integrate into the system. You always take a little bit of risk as you pay for the compensation and try to ensure that referrals stay within the system. But yeah, I mean it seemed like there was a pattern of regional partnerships over the past four or five years and less of some of these sprawling, spread out ones. But what did you make of that dichotomy between trying to go big for that and trying to gain efficiencies of scale, versus, you know, others that have taken a different approach?
Tara Bannow: Yeah. I mean, I think that’s a really reasonable question to ask. I mean and I think another complicating factor with CommonSpirit in particular is they had different operating structures, with Dignity being more centralized and CHI being kind of led by these regional arms. So I imagine that was kind of difficult to navigate culturally as a larger system. CommonSpirit … I mean, analysts have kind of pointed to the fact that CommonSpirit is trying to sort of refine its profile. They added Virginia Mason in Seattle, which was a really good get for them. They tried unsuccessfully to sell some hospitals in the Midwest to Essentia. So you can tell they’re kind of trying to, you know, give themselves a better overall platform. So whether that will work sort of remains to be seen.
I think what was interesting too with CommonSpirit is in Texas when we saw CHI St. Luke’s raise this contract dispute with Blue Cross Blue Shield of Texas mid-contract and said, “Our rates aren’t high enough. We want more money or we’re out.” And that’s very unusual to do. I mean, usually that kind of stuff comes up at the end of a contract, but, you know, I think this shows that CommonSpirit isn’t afraid to use its market power and flex its very large muscles when it comes to contracting. And then they did actually reach a new contract agreement. So I guess it worked. And also, interesting from a branding perspective, Lloyd Dean told me that they are keeping things pretty much separate indefinitely. So CHI will stay CHI. Dignity will stay Dignity. Lloyd said that CommonSpirit is kind of a house of brands, so it makes sense to harness this local recognition that CHI Franciscan has, for example.
Alex Kacik: Yeah. And that’s interesting too, because you always get to a point of when you’re talking with these analysts on how thorough is their integration, and one of the things at least from just a optics perspective is when you’re not sharing the same name and you kind of remain as a separate institution, maybe you keep those silos up too, depending on whether you have more of a centralized, you know, governance structure or one that’s a hub and spoke model. And so yeah, I mean that factors into it too. And you mentioned the contract dispute. I know Dignity had one come up with Anthem, Blue Shield in their California region and they resolved that, but it’s always interesting to see that back and forth and how much negotiating leverage each party thinks they have. But, you know, when it comes to CEO tenures, they were already getting shorter prior to the pandemic and it’s a competitive market for CEOs, and many would get poached away by other systems that would pay more, but it seems like the pandemic has maybe even expedited some of that CEO turnover.
Tara Bannow: Yeah. I mean, there’s been a lot of CEO retirement announcements since the start of the pandemic. It’s impossible to say if these were entirely pandemic driven. I mean, it could be a number of factors. Maybe the pandemic was the straw that broke the camel’s back, but some big ones were Baylor Scott & Whites, Jim Hinton, and Acadia Healthcare’s Debbie Ostein, Alina Health’s Dr. Penny Wheeler, Sutter Health’s Sarah Krevens. One analyst I talked to about this said, “The world has changed a lot since early 2020. We’re kind of operating in a new paradigm in healthcare and every area of our lives.” So for many, maybe the next five years or so, is the appropriate time to hand off the baton to somebody who wants to kind of work and lead systems in this new world.
Alex Kacik: Sounds good. So what’s the outlook for CommonSpirit? You know, when you’re talking to analysts, what are they keeping an eye on as they look at, you know, what their next steps are as a system? I know they are seemingly selling some operations off the non-core markets of their business. You mentioned, you know, a couple mergers that were proposed out in the West with CHI Franciscan. And yeah, what’s their gauge on what are they going to be keeping an eye on moving forward to see if CommonSpirit progresses?
Tara Bannow: Analysts are cautiously optimistic. I think they’re encouraged by the financial improvement they’ve seen so far, but they want to definitely get a sense for how CommonSpirit plans to keep that momentum going and improve the finances further. You know, I think it’s impossible to say at this point what exactly will happen there. Lloyd Dean said that CommonSpirit is currently being re-evaluated, re-rated by all three credit rating agencies. And he said he expects better ratings this time around. I think he’s hoping things will look good. The credit rating agencies for their part were a little bit more mum on that point.
But I think people, you know, analysts and others are also looking hard at that $2 billion cost savings goal that CommonSpirit has talked a lot about, and they want to see, you know, more detail around that, around how they plan to get there and when they’ll get there. I think the pandemic has sort of slowed that down a little bit. They’re not exactly at the pace that they wanted to be initially, because obviously preparing for and treating COVID patients and rolling out the vaccinations and getting adequate labor during the pandemic has been a really big challenge for CommonSpirit and others. But yeah, I think once we have more progress and detail toward the cost savings goal, that will improve the margins as well.
Alex Kacik: All right, Tara, thank you so much for breaking this down for us.
Tara Bannow: Yeah, thanks for having me. This was fun.
Alex Kacik: All right. Thank you all for listening. If you’d like to subscribe and support our work, there’s a link in the show notes. You can subscribe to Beyond the Byline on Spotify or wherever you listen to your podcast, and you can stay connected with our work by following Tara and I at Modern Healthcare on Twitter and LinkedIn. We appreciate your support.
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