Epic Battle Erupts Over Control of Pittsburgh Healthcare

“You report to me, and you do what I tell you!” said, it is alleged, John Paul, an executive with Pennsylvania’s largest health insurer to the CEO of Pittsburgh’s second largest hospital system, Keith Ghezzi.

And what did Mr. Paul want Mr. Ghezzi to do?  According to testimony submitted as part of a November 2012 court hearing where the two companies are fighting over the future of the hospital network, Mr. Paul wanted Mr. Ghezzi to put his hospital chain into bankruptcy.

And why would Pennsylvania’s leading insurance company want to put a venerable 125-year-old Pittsburgh-based hospital system into bankruptcy?

Because they can.

When Insurances Companies Take Over

In November 2011, Highmark Insurance Company, Pennsylvania’s Blue Cross Blue Shield provider and the largest health insurer in the state offered to buy the West Penn Allegheny hospital system for $500 million and assumption of $1 billion in debt.

There was, however, one problem with the deal.  Highmark is an insurance company and provides coverage to not only West Penn Allegheny, but other hospitals in the region including the largest system in the region—University of Pittsburgh Medical Center (UPMC).

Highmark holds a 60% share of the health insurance market in the Pittsburgh area. UPMC, as it turns out, holds a 58% share of the inpatient market in the Pittsburgh area.

By acquiring West Penn Allegheny and funnelling dollars (including, no doubt, funds that would otherwise have gone to UPMC) into it, Highmark Blue Cross Blue Shield was becoming UPMC’s competitor.

These developments occurred at roughly the same time that UPMC had been trying to negotiate a 40% increase in payments from Highmark.

In response to Highmark buying its much poorer cross town rival, UPMC cancelled its ten-year contract with Highmark and immediately sought bids from Aetna, United Healthcare Group, Coventry and Cigna.  Given Highmark’s dominant share of the Pittsburgh health insurance market, the majority of the people residing in the Pittsburgh area were now out of Blue Cross Blue Shield’s coverage area if they received service from UPMC.

Highmark didn’t seem fazed by UPMC’s cancellation.  It announced the acquisition of yet another hospital—the Jefferson Regional Medical Center in Jefferson Hills (a suburb of Pittsburgh) for $75 million. Then it announced that it was also buying the Premier Medical Associates in Monroeville, Pennsylvania. as well as a growing number of properties, particularly in the North Hills section of Pittsburgh.

In case there was any doubt, Highmark’s executives, led by John Paul, made it clear in interviews and press releases that these hospital purchases were part of a broader strategy to build a $1billion integrated delivery network of hospitals, clinics and other service providers in the Pittsburgh area.  And, yes, that new system would compete with UPMC.  And, yes, the center piece of that system would be West Penn Allegheny.

If UPMC wanted to go to Aetna, United, whatever—let them.  He who writes the checks steers the patients.

Highmark Blue Cross Blue Shield

Highmark was created in 1977 and became the largest health insurer in Pennsylvania in the 1990’s by consolidating under the Highmark banner two Pennsylvania licensees of the Blue Cross and Blue Shield Association—Pennsylvania Blue Shield (now Highmark Blue Shield) based in suburban Harrisburg, and Blue Cross of Western Pennsylvania based in downtown Pittsburgh (now Highmark Blue Cross/Blue Shield). Highmark now serves 49 of Pennsylvania’s 67 counties. In West Virginia, the company operates as Highmark Blue Cross Blue Shield West Virginia, and in Delaware, it operates as Highmark Blue Cross Blue Shield Delaware.

Last year Highmark reported annual sales of nearly $15 billion and reserves of around $4 billion.

West Penn Allegheny

West Penn Allegheny Health System (WPAHS) is the second-largest provider of healthcare in Pittsburgh and was originally created by combining Western Pennsylvania Hospital (West Penn), founded in 1848 as Pittsburgh’s first chartered public hospital, and Allegheny General Hospital (AGH), which was founded in 1886. WPAHS employs approximately 13, 000 people with a medical staff of 2, 726. The system offers 46 graduate medical programs, operates two nursing schools, and serves as a clinical campus for the medical schools of Drexel University and Temple University, which are located in Philadelphia.

For the last half of the year ended in 2011, West Penn Allegheny lost $56 million and had its bond rating reduced by Moody’s rating service to Caa1with a negative outlook.  Even West Penn’s auditors could not assure bond holders in its most recent financial report that West Penn could survive through 2012.

In the most recent 2012 financial report, West Penn Allegheny’s executives said that they’d lost business to the University of Pittsburgh Medical Center, which contributed to a drop in the number of hospital discharges in July, August and September compared with the same three months in 2011.

West Penn Allegheny’s readily available cash—which has been bolstered by an infusion of $200 million from Highmark—was only enough to cover its operating expenses for 55 days.

Highmark Pushes for West Penn Bankruptcy

This past September Highmark, before the acquisition was completed, proposed forcing West Penn’s bondholders to accept a 40% principal reduction to between $326.6 million and $435.5 million, and to unload the health system‘s pensions, which are underfunded by about $280 million to the Pension Benefit Guaranty Corp. It was a proposal to push West Penn into court supervised bankruptcy.

Led by its interim CEO, Ken Ghezzi, West Penn Allegheny rejected Highmark’s demand.  Whereupon Highmark’s President John Paul reportedly said to West Penn’s Ghezzi: ““You report to me, and you do what I tell you!”

On September 28, West Penn announced that the Highmark deal was off.

Shocked at the sudden reversal, groups of West Penn’s own physicians publically called for Ghezzi’s firing while also demanding that the Highmark deal proceed.

Highmark sued.  West Penn lost.

So, just before this past Thanksgiving, West Penn’s board member Paul Dimmick took over the merger negotiations with Highmark.  West Penn’s Board Chairman, Jack Isherwood, said that negotiations would begin in earnest right after Thanksgiving.  Just after Christmas, Highmark’s CEO William Winkenweder said that he expected an acquisition agreement between his firm and West Penn to be completed in January 2013.

Is Pittsburgh the Canary in the Coal Mine?

Highmark’s decision to “bear hug” West Penn Allegheny and risk the ire of UPMC may well be part of a larger trend which is a response to a multitude of changes occurring in the U.S. healthcare system including, but not limited to, the Accountable Care Act (ACA)—aka: Obamacare.

The ACA states that health insurance companies may not turn away costly patients with pre-existing conditions or charge higher rates to women, for example, and must cover maternity care and prescription drugs that pre-ACA plans would not necessarily cover.  The law also requires that health insurers spend at least 80% of the premiums they collect on medical care—which puts a cap on profitability.

Within that context, vertically integrating down to the hospital and clinic level appears to be a wholly rational decision.  As a more integrated enterprise, insurance companies like Highmark hope to better control the new costs brought about as a result of the ACA and the rise of non-insurance revenues can help to restore or even bolster profitability.

In the case of West Penn Allegheny, no longer will its CEO be able to sit down with Highmark’s executives to negotiate more favorable insurance payments.  That person is now his boss.  His P&L is Highmark’s P&L.

There is little doubt that the health insurance industry is in the midst of a seismic shift.  Even beyond the ACA rule changes, approximately 25 million people will now be able to buy health insurance through regulated “exchange” marketplaces.  Medicaid is expected to add 11 million people to its rolls.

In addition to examples like Highmark’s purchase of West Penn Allegheny, United Healthcare has been purchasing primary care practices.  Last year Aetna purchased Coventry Health Care for $5.6 billion—which is the largest such acquisition ever.  The merger with Coventry gives Aetna better access to the Medicare and Medicaid population and 5 million more policy holders.

Also in 2012 WellPoint announced that it would acquire Amerigroup Corp., for $4.9 billion.  Amerigroup is a company which supports state Medicaid programs.  Finally, in January 2012 Cigna bought HealthSpring, Inc., another Medicare plan provider, for $3.8 billion.

The U.S. healthcare industry is a $4.78 trillion enterprise.  It is being transformed by a variety of forces.  Fundamentally, it appears to be consolidating in several ways—both horizontally and vertically (Highmark’s purchase of West Penn Allegheny is a vertical consolidation)—and appears to be trying to move from a procedure based system to an outcome based system.

These changes are going to drive companies to re-examine some fundamental questions.  For suppliers, it will challenge the idea of “customer.” Is this business still basically a “peer-to-peer” sales business?  Or has the payer become the customer?  It will also challenge the notion of “outcomes.” Remember, no outcome, no income.  So is an “outcome” for a payer the same as an “outcome” for a physician?

For patients and physicians in Pittsburgh, the epic battle that has been raging between the two healthcare goliaths in that city—UPMC and Highmark—provides new answers to such questions. Who is the “customer” in Pittsburgh?  For more than half the market, the answer is Highmark.