August 11, 2018
The respective governing boards at Dignity Health and Catholic Health Initiatives have encountered multiple setbacks in their quest to merge the two organizations since formal negotiations began in 2016, and there are few indications that they will consummate the deal soon.
Paperwork filed with the California attorney general hint at some fundamental problems with combining the organizations, which have contrasting financial standings and differing management structures. The deal also needs approvals at multiple levels within the Catholic Church.
“The most difficult problem is psychological—the employee morale problem and loss of momentum caused by the delay,” said Charles Francis, Dignity’s chief strategy officer, at a June 2017 board meeting, according to the meeting minutes. He went on to say that CHI’s leadership is just as frustrated as Dignity’s about the delay, which he said at some point could render the deal’s financial goals more difficult to achieve, with the deal even reaching an “expiration date” at which point those financial goals would become impossible.
When Dignity’s board and religious sponsorship approved going ahead with the merger in April 2017, meeting minutes show directors expected the deal to close in October 2017. But the two health systems have so far just signed a definitive agreement to merge, and that didn’t take place until December 2017.
Documents that Dignity posted on its website as part of its application with California’s attorney general don’t say exactly what’s behind the delay—likely a combination of factors—and many documents are redacted or omitted entirely.
The two systems need to get it right, as California Attorney General Xavier Becerra has proven he’s anything but a pushover. He sued Northern California’s largest health system, Sutter Health, in March accusing it of anti-competitive behavior that he says has driven up healthcare prices. He also denied requests from several hospitals to lower their charity-care obligations.
Nonetheless, representatives for both Dignity and CHI say they remain fully committed to the union and are on track to close the deal by the end of this year to create a new health system with $28.4 billion in estimated annual revenue.
“We recognize that a complex alignment like this can take time, and our goal is to come together in a way that will best position us to deliver health care into the future,” a Dignity spokesman wrote in an email.
The Federal Trade Commission did not raise concerns about the proposed deal ahead of an April deadline to do so.
Some of those paying attention to the pending deal aren’t surprised it’s taking longer than expected. With a deal of this size, a delay is par for the course, said Kevin Holloran, a senior director with Fitch Ratings. “It’s probably a little bit frustrating for the folks on the ground, but I would say ultimately having this long due-diligence phase to make sure it works is more important,” Holloran said.
A CHI spokesman emphasized that combining two entities of this size is very complicated. “While this process has taken longer than anticipated, it was important to take the time necessary to fully assess the proposed alignment, given the complex nature and size of the combination,” he wrote in an email.
C. Timothy Gary, CEO of Nashville-based consultancy Crux Strategies, said mergers always take longer than the parties expect. The problem with some deals is they assume a “growth for growth’s sake” strategy, but he said these systems have different footprints and similar approaches to the market. “The whole is better than the sum of the parts,” he said. “It appears to me they’re approaching it for the right reasons and raising very legitimate, very appropriate questions and they’ve engaged in a thoughtful process, versus, ‘We’ve set a deadline and we’ve got to get it done.’ ”
CHI-Dignity merger fun facts Dignity Health filings with the state of California include some interesting tidbits of information from Dignity’s board meeting minutes:
Like any health system merger, a culture clash carries the potential to derail the whole operation.
Dignity and CHI commissioned a “bottom-up” culture assessment to ensure that doesn’t happen. About 25,000 CHI employees and 28,000 Dignity employees provided survey responses, 50 executive leaders gave interviews—18 at CHI and 32 at Dignity—and staffers participated in 20 focus groups. Dignity’s board reviewed the results at a March 2017 meeting. When asked to name their organization’s top 10 strengths, seven answers were the same among CHI and Dignity employees. Asked to provide three words to describe their respective health systems, two words repeatedly shared by both CHI and Dignity employees were “compassionate” and “caring.”
The study concluded that both health systems display strong organizational health, compatible missions and values, healthy competition and supportive work environments.
But Dignity’s board meeting minutes show directors discussed more than once the difference in how CHI’s management team relates to its governing bodies and religious sponsors. At a January 2017 board meeting, Chairwoman Tessie Guillermo said CHI’s management is less transparent with its governing bodies.
“In her interactions with her CHI counterparts, they appear to have less information about their operations and management activities than the Dignity board does,” minutes from that meeting state.
Dignity has long operated with a more centralized management style, where a senior management team oversees all operations, said Martin Arrick, a managing director in Standard & Poor’s Global Ratings’ not-for-profit healthcare group. That structure, which health systems have been transitioning to in recent years, makes it easier for management to pass along information to its board. CHI, by contrast, operates more as a collective of local ministries, although it is moving toward the centralized structure.
Arrick said he doesn’t think CHI’s management is trying to keep its board in the dark. Rather, the information its board receives is a product of how the health system is structured.
“I think an outgrowth of an operating model is the quality of information you get,” he said. “It’s better, more consistent and therefore easier to pass upstairs, so to speak.”
Once the two systems merge, Arrick said he thinks they’ll move toward Dignity’s model.
Early in discussions about the merger, which Dignity’s board calls “Project Bear,” documents show Dignity executives and directors were very uneasy about CHI’s financial position.
Dignity Chief Financial Officer Daniel Morissette wrote in a March 2017 memo that management is approaching the deal with “rigor and skepticism.”
“While the potential of the combined ministry to achieve scale and impact for Catholic healthcare is compelling, there are financial and operating risks embedded in a transaction of this nature,” he wrote. “Added to this is the current weak financial position of CHI, a troubling track record of financial decline, unsuccessful turnaround plans, loss of credibility with the financial markets and rating agencies, and other operating issues.”
At that time, there was no evidence that CHI’s turnaround was going to stick, Fitch’s Holloran said. S&Pand Moody’s Investors Service cut their debt ratings for the health system, and Fitch had done the same eight months earlier.
CHI posted a $585.2 million operating loss in its fiscal 2017, ended June 30, compared with a $371.4 million operating loss in the previous year.
That’s in contrast to 2018, when CHI’s effort to turn matters around is starting to show promise. In fiscal 2018 the system just about broke even in the second quarter, with results released in February showing an operating loss of $1.5 million, compared with a $146 million loss in the prior-year period. In the third-quarter results, released in May, however, CHI’s operating loss jumped to $35.3 million, steeper than its $17.2 million operating loss during the same period the prior year.
“Are we sure that we can right the ship, so to speak? I think today the answer is ‘yes,’ but back then the answer was really ‘no,’ ” Holloran said.
Not only that, but President Donald Trump took office in January 2017 after running on the promise to repeal and replace the Affordable Care Act, a move that would have a huge impact on two health systems that benefited greatly from Medicaid expansion.
Dignity’s spokesman wrote in a statement that since 2017 leadership teams at both organizations have, together and independently, conducted extensive financial due diligence. The mutual decision to move forward reflects confidence that, over the longer term, the alignment will result in a stronger, more sustainable organization in the future.
As part of the deal, Dignity has committed to keeping charity care at the 31 hospitals it operates in California at current levels for six years following the deal’s close, going one year beyond what is generally required by California law.
Dignity’s spokesman wrote in an email that the system has a long-standing commitment to serving everyone in its communities regardless of their ability to pay.
“This alignment will strengthen our ability to care for all patients, including those most in need, and our new combined health system will remain deeply committed to meeting the health and social needs of all of our communities and maintaining charity care and community health programs that help care for the most vulnerable patients,” he said. “Our charity-care commitments in our application to the California attorney general regarding our California hospitals is one example of that commitment.”
In their 2017 financial reports, CHI and Dignity reported providing $252 million and $99 million in charity care, respectively. CHI’s charity care represented 1.6% of the organization’s total expenses that year, while Dignity’s represented 0.76% of its total expenses.
To determine how much charity care its California hospitals will provide, Dignity compiled an average from the prior three years. In some cases, that means charity care will jump dramatically from fiscal 2017. For example, California Hospital Medical Center in Los Angeles provided $6.4 million in charity care in fiscal 2017, and its minimum required amount following the transaction will be $12.2 million. Northridge Hospital Medical Center provided $2.5 million in fiscal 2017 and its minimum required amount will be $5.2 million.
In other instances, charity care will decline under the requirement. For example, St. Joseph’s Medical Center of Stockton provided about $3 million in fiscal 2017, but it will only have to provide $2.6 million after the deal closes.
It could also be a move to appease California’s attorney general, who has shown a fierce commitment to ensuring not-for-profit health systems live up to their tax-exempt status. At deadline, Becerra’s office was expected to release a health impact statement on the proposed deal Aug. 10, with public hearings to follow.
Most recently, Becerra denied requests from three hospitals to cut their charity care by more than half.
Those hospitals, with the help of the California Hospital Association, had argued that after the ACA’s Medicaid expansion, there were no longer enough patients who met their financial eligibility criteria.
A number of consumer advocacy groups, including the National Health Law Program and the ACLU of Southern California, are asking California’s attorney general’s office to require Dignity hospitals to continue providing charity care, community benefits and essential healthcare services at the same levels for a minimum of 10 years. The groups also want the attorney general to use the average of the previous five years of charity care to calculate the amounts those hospitals will need to provide, rather than three.
Dignity’s spokesman said the charity-care commitments apply only to its California hospitals, and declined to say what levels of charity care its eight hospitals outside of California will provide following the merger. A CHI spokesman wrote in an email that although Dignity’s commitment is unique to California’s approval process, CHI expects to maintain its level of charity care.
Susan Sherry, deputy director of the consumer advocacy group Community Catalyst, said California’s charity-care requirement is unique, extensive and “incredibly good for people in California.” “I think it’s really protecting things that the public really thinks are important,” she said, “and it’s clearly consistent with the mission. It’s kind of the concrete manifestation of a real commitment to the mission.”