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Struggling CHI stands to benefit from merger with Dignity

Updated 11 a.m. ET

After more than a year of discussions, Dignity Health and Catholic Health Initiatives have signed a definitive agreement to merge. The combination will create the nation's largest not-for-profit hospital system by operating revenue.

The new health system would have 139 hospitals and a combined revenue of $28.4 billion with more than 159,000 employees, and 25,000 physicians and other advanced practice clinicians. The combined system would have operations in 28 states with no overlap in hospital service areas, which could help expand access and also help from a regulatory perspective, executives said.

CHI and Dignity would form the largest not-for-profit hospital company, in front of St. Louis-based Ascension with $22.6 billion of revenue. Both significantly trail Kaiser Permanente, the nation's largest not-for-profit integrated system, which boasted $64.6 billion in revenue in 2016.

Executives said in a news release that the marriage would allow them to expand outpatient and virtual care settings closer to patients' homes, broaden clinical programs including ones that treat chronic illness, and advance digital technology like stroke robots and Google Glass that will facilitate more personalized and efficient care.

CHI CEO Kevin Lofton and Dignity CEO Lloyd Dean will serve as co-CEOs, each with specific and independent responsibilities and decision-making authority. Lofton will have authority for mission, advocacy, sponsorship and governance, system partnerships and information technology, while Dean will have authority for all of operations, including clinical, financial and human resources.

"At the core of what we are trying to do sits the patient and consumer," Dean said. "We are looking at using our combined scale to capture the best-in-class clinical service lines and retain and attract the best talent, and look at how can we standardize our operations to improve patient experience, improve quality, reduce cost of care and use our voice to impact the direction and capacity of healthcare in this country."

The combined entity could spread costs over a bigger platform, expand access in rural communities and use complementary skill sets to face competitive markets, Lofton said.

Hospitals and health systems have been consolidating at a rapid clip in both horizontal and vertical mergers on national and regional scales, in part to offset margin pressure felt from rising labor and technology costs, and to satisfy new payment models that mandate more integrated care. While hospital executives claim that scale is needed to lower costs, researchers point to the contrary and say consolidation often produces higher prices and insurance premiums.

Dignity Health and Sutter Health were the focus of a that revealed the dominant hospital chains drove up healthcare prices as they expanded over a 10-year period. Glenn Melnick, an economist at University of Southern California's Schaeffer Center for Health Policy & Economics, and co-author Katya Fonkych found that Blue Shield of California's average payment per admission to Dignity and Sutter facilities increased 113% from 2004 to 2013—$9,183 to $19,606.

Still, the CHI-Dignity tie-up could help accelerate CHI's financial turnaround, analysts said.

The deal could allow the financially struggling CHI to refinance its debt based on the higher credit rating of Dignity, which would also have more negotiating leverage with payers, said Harry Bramson, a senior associate at consulting firm Conway MacKenzie.

"This is a pretty familiar story in healthcare where the acquiree takes on a lot of debt, becomes less profitable over time and then can no longer make the critical investments it needs in cap-ex, equipment and technology," Bramson told Project Japan in October. "By merging with Dignity, CHI can get help with making these investments."

The governing board for the new organization will include six members from each legacy board as well as the two CEOs. The new health system will establish its corporate headquarters in Chicago and operate under a new name that will be chosen in the second half of 2018. Local facilities will continue operating under their current names.

More systems have been taking the co-CEO approach. The recently announced Advocate Health System and Aurora Health System would also employ a similar structure, and Bob Garrett and John Lloyd have been co-CEOs of Hackensack Meridian for more than a year.

While some experts have criticized shared leadership structures that could disrupt culture and continuity, Bob Garrett and John Lloyd said their shared roles have worked well.

"Because each organization had different strengths, we thought the shared governance model would work really well," Garrett said in a with the Advisory Board.

The CHI-Dignity deal builds on CHI's and Dignity's Precision Medicine Alliance formed in September 2016, which the two systems called the nation's largest community-based precision medicine program. The new organization seeks to become a national platform for innovation and research, positioning it as an attractive partner for other entrepreneurial organizations, according to the news release.

San Francisco-based Dignity, which has 39 hospitals, to $66.8 million in fiscal 2017, up from $63.4 million last year, thanks to a decline in payer mix as well as delays of the state's provider-fee program payments, which subsidizes hospitals that treat a large share of indigent patients, executives said during the call.

Dignity reported a net surplus of $383.6 million on the year ended June 30, up from a net loss of $237.8 million, and powered by investment income of $555.5 million after a loss of $124 million in fiscal 2016.

Englewood, Colo.-based CHI is amid a turnaround plan that includes selling money-losing hospitals in Louisville, Ky., and exiting the insurance business.

The 100-hospital system saw its operating losses widen to $585.2 million in 2017 from $371.4 million last year.

Non-operating income, including investment income, increased to $713.6 million in 2017 compared with a loss of $204.2 million in 2016. That allowed CHI to post a net surplus of $128.4 million for the year compared with a net loss of $575.6 million last year.

CHI posted a 16.4% increase over 2016 in earnings before interest, depreciation and amortization—or a total of $810 million—before restructuring charges.

The company said its operations in Texas continued to struggle in 2017, while its Denver area and Tacoma, Wash.-based Pacific Northwest division reported strong performances.


Alex Kacik

Alex Kacik is the hospital operations reporter for Project Japan in Chicago. Aside from hospital operations, he covers supply chain, legal and finance. Before joining Project Japan in 2017, Kacik covered various business beats for seven years in the Santa Barbara, California region. He received a bachelor's degree in journalism from Cal Poly San Luis Obispo in Central California.

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