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Anatomy of a Bankruptcy

Part 3: Full steam ahead

Wednesday, January 20, 1999
By Steve Massey, Post-Gazette Staff Writer

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It didn’t take long for Sherif Abdelhak, the newly named chief executive at Allegheny General and its parent organization, to make his mark — and in so doing, to lay out his plan of attack in the increasingly challenging environment of health care economics.

Even before he assumed the reins in 1986, Abdelhak was hearing the rumblings. If the hospital hoped to retain its longtime academic and research components, features that were vital to bringing in new dollars, it would have to link up with a medical school. Congress and the medical licensing bodies were saying so. So were hospital administrators and medical journals.

And so was Claude Joyner, the hospital’s chairman of medicine. While nothing had been done yet, it had become accepted wisdom that, in order to better control Medicare and Medicaid expenditures, the government would soon move to require that subsidized hospital residency programs — something AGH had had for decades — go through an academic institution.

For Allegheny General, that meant one thing: It would have to go shopping for a medical school.

There was no way the University of Pittsburgh was going to allow its largest competitor to have anything more than an incidental relationship with its medical school. Pitt did send perhaps a couple dozen medical residents to AGH every year. But even that meager affiliation was beginning to fray.

There were some overtures to Carnegie Mellon University in the early 1980s about creating a medical school. But those inquiries didn’t go anywhere. And Duquesne University, at this point in its life in the mid-1980s, was simply too weak financially and academically to be considered an option.

But if others saw Allegheny General’s plight as an obstacle, Abdelhak seized it as an opportunity. With its own medical school, Allegheny General would no longer be subservient to Pitt, a position that grated on the nerves of many AGH doctors as well as on William Penn Snyder III, the longtime chairman of the hospital and its parent board, and other board members too.

After all, Allegheny General in the mid-’80s was more profitable and bigger than Pitt’s Presbyterian-University Hospital, and it was equally advanced in several areas of medicine, including trauma, cancer and cardiac care. It had been the first hospital in the region and among the first in the country to offer helicopter service. It had been an early pioneer in nuclear medicine and had a national reputation for heart transplants and cutting-edge cardiac surgery.

There may never be a better time to break ranks with the superior-minded University of Pittsburgh Medical School.

Besides, with cost pressures growing on hospitals from the stingier Medicare and Medicaid programs and from insurers, Allegheny General needed medical residents. They’re the hospital’s version of hamburger flippers and store clerks. Thanks to government subsidies, which cover the costs of training, they’re low-wage worker bees. The only difference is they provide high-wage care, from the emergency room to the operating room.

And by expanding clinical and basic science programs, Allegheny General could woo research dollars and high-priced talent, raising its status as an integrated health care provider that not only heals the sick but also develops new cures and methods of care. If it had a weakness, it was the relatively meager amount of research dollars it attracted. A med school would address that and help fix it.

Allegheny General’s shopping list wasn’t long, and for good reason. There weren’t many medical schools looking to be bought.

Moreover, its desire to stay in-state — and thus avoid problems with interstate licensing — limited its prospects. So did its goal of finding a school at least 250 miles away so that competition for clinical patients between it and its new partner wouldn’t become an issue. The last things Allegheny General doctors wanted were another hospital trying to lure away patients and a bunch of academics meddling in their affairs and undermining their authority. Distance had a way of solving these problems.

Given the parameters of the search, there was only one clear place to look — Philadelphia. It had six medical schools, and at least one, the Medical College of Pennsylvania, was in deep distress. It didn’t even have enough money to repair a leaking roof in its main building. Joyner, who had worked in Philadelphia for two decades, put out feelers and was told the college would be open to a combination.

At Allegheny General, there was some apprehension among doctors and a few board members, including Vincent Sarni, the hospital’s chairman and chairman of PPG Industries.

Sarni was skilled at counting pennies and perusing balance sheets, and he wanted assurances that an MCP acquisition wouldn’t harm AGH. Doctors also were concerned that the medical school could end up detracting from their work in Pittsburgh.

But those concerns were easily overcome by Allegheny General’s desire to have its own medical school. It would be unprecedented for a nonprofit hospital to buy a med school, but these were unprecedented times. Across the country, teaching and university-related hospitals, confronted with mounting fiscal pressures in the wake of government cuts, were starting to link up with for-profit chains.

The only difference here was that AGH was nonprofit. That made it easy for the state attorney general’s office to sign off on the deal. By law, the office, which is responsible for overseeing charitable organizations, didn’t even have to do a review because one nonprofit was taking over another. (The attorney general’s office stuck to that position in subsequent years as Allegheny was building its empire, often as a white knight coming in to take over struggling nonprofit brethren.)

 
   

Snapshot of AHERF
June 30, 1992

Employees: 13,125
Revenue: $893.2 million
Assets: $1.12 billion
Debt: $367 million
Inpatient admissions: 68,394

* Based on Allegheny Health Education and Research Foundation and tax documents

 
 

Most everyone agreed that a medical school would open the door to more research dollars, recruits and prestige. And Abdelhak assured doctors and the board that no more than $4 million to $5 million a year would be needed to prop up MCP. There was even some thought of moving the school to Pittsburgh. And doctors would soon discover they liked seeing the title, "Associate Professor," on their letterheads.

So the deal was cut in late 1987. And on April 27, 1988, Allegheny General’s parent — then called Allegheny Health Services — and MCP announced that the medical school would become part of the Allegheny organization and that Allegheny would pump $40 million to $60 million into the school over the next five years, with groundbreaking for a new office and parking complex to begin the following year.

No one knew it at the time, but Allegheny Health’s Philadelphia story was just beginning.

Less than two years after the MCP deal, Allegheny and Hahnemann University, another Philadelphia medical school, only bigger and better endowed than MCP, began discussing a possible merger. The late 1989-early 1990 conversations were limited and relatively secret, involving just a few advisers as well as Abdelhak and Iqbal Paroo, Hahnemann’s chief.

At the time, Hahnemann and its inner-city teaching hospital were beginning to feel the pinch all urban medical centers were feeling. It was brought on by mounting restrictions on payments for care to the poor and elderly and a shift by managed-care insurers away from higher-cost teaching hospitals. Hahnemann could use a stronger financial partner.

For Allegheny, Hahnemann brought to the table something MCP lacked — a wide array of clinical programs that could give medical school students more on-site training and a new avenue to attract more private dollars for research now that the government continued to cut back.

MCP’s focus was more on basic research, the sort of arcane scientific experimentation that can lead to medical breakthroughs.

Hahnemann was more clinical — its doctors had their own practices and brought in both patients and industry-funded research. And it performed more open-heart surgeries than any other Philadelphia hospital by far.

The merger talks were fairly advanced when the potential combination collapsed. Some say the deal died because Abdelhak and Paroo were too much alike and clashed, others because of an uproar among MCP faculty who feared the loss of their new-found status as big fish in the hospital foundation’s academic pond. MCP doctors and administrators clearly made their displeasure known when word of the potential combination leaked out, and Abdelhak, in a public statement after talks collapsed, said the decision to abandon the merger was MCP’s to make and that he would stand by it.

Yet Abdelhak was undeterred. Even as his organization was talking with Hahnemann, it was eyeing St. Christopher’s Hospital for Children, one of only two pediatric hospitals in the Philadelphia area. MCP was thin in pediatric specialties, and St. Chris, part of the ailing United Hospital System, appeared to be available.

But to get St. Chris, Allegheny also would have to pick up United’s three struggling suburban hospitals — Warminster, Rolling Hills and Lawndale. The three hospitals didn’t offer much to the mix. MCP didn’t really need more beds in an already overbedded market; it was looking to expand training and research through the reputable children’s hospital. But when Allegheny offered $75 million just for St. Chris, it was rebuffed.

A few board members suggested putting off a deal until United went bankrupt. Then Allegheny could pick up St. Chris on the cheap. But Allegheny wasn’t the only one interested in St. Chris, and it didn’t want to get in a bidding war in the highly competitive Philadelphia market, where hospital mergers and acquisitions were starting to take off.

Temple University School of Medicine already had a strong affiliation with St. Chris, which served as its department of pediatrics. No way would Temple sit by idly and let Allegheny take over St. Chris in a bankruptcy court auction. United also had held merger talks with Hahnemann University Hospital and Graduate Hospital, another inner-city hospital.

Better to act now than to wait and possibly lose, Abdelhak argued. The suburban hospitals could serve as feeders, expanding Allegheny’s reach into more affluent parts of Philadelphia, where patients with better insurance coverage and deeper pockets could be funneled into its inner-city teaching and research hospitals for higher-cost specialty care.

Everyone could see that the world of health-care economics was rapidly changing. Cost controls and declining government and insurance reimbursements had replaced the era of easy money. If you could control the flow of patients, you could have more control over your destiny.

Bigger was still better, but not just because it meant more money, but because it also meant there were more opportunities for efficiencies and to bargain with insurers.

Economies of scale — the ability to maximize profits by spreading costs over a bigger base of patients — was the driving force behind health care consolidation. Eliminate excess beds; centralize purchasing, accounting and information services; and gain enough market share to negotiate with insurance companies from a position of strength. That was a particular need in Philadelphia, where a bruising battle was taking place between health insurance giants U.S. Healthcare and Independence Blue Cross. Together they accounted for more than eight of every 10 privately insured patients.

For Allegheny, there was an added plus: with a major presence in Pittsburgh and Philadelphia, it could offer a true cross-state network of hospital care to PNC Bank, Mellon Bank and other organizations with statewide operations.

It was enough to convince the Allegheny board. So three years after taking on MCP, a second deal was cut — though not without controversy.

For one, directors learned at the last minute that scores of United managers had obtained sizable severance packages — a surprise that was repeated just two years later, when Allegheny ended up getting Hahnemann after all.

And investors awaiting a $60 million bond issue by Allegheny General Hospital weren’t told about the talks with United until after the bond sale. Now they were left wondering if Allegheny General could get stuck helping support the rapidly expanding Philadelphia operations.

Allegheny worked quickly to stem the fallout. It said it expected to generate substantial savings by slashing the United payroll, and, within a year, it closed the 63-bed Lawndale hospital and terminated almost 300 workers.

It also emphasized that the United transaction was entirely separate from the AGH bond issue, so that bondholders bore no financial obligation or guarantees for the United hospitals. Finally, it said it wouldn’t assume any of United’s $137 million in long-term debt.

Of course, over time, the parent organization did take on United’s long-term debt, through the creation of a new subsidiary that fell under the Allegheny umbrella. And Allegheny General did help prop up the hemorrhaging Philadelphia operations — money made available because frequent bond sales helped free up cash for other uses.

Still, in January 1991, all that really wasn’t an issue. The bottom line was that the troubled United system had a new owner, one that by all appearances was deep-pocketed and committed to quality. Its profit margins may have been on the decline, but it still had substantial resources and a track record for performance — a year after the merger, the United hospitals were posting profits and their bond ratings were upgraded.

The burgeoning Allegheny empire now consisted of a medical school and five hospitals in the City of Brotherly Love, while back at home in Pittsburgh, it was eyeing 100-plus-acre parcels in the North Hills and South Hills for expansion.

The Allegheny steamroller was going full steam.

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