Strong Medicine: Health System Cuts 1,700 After Record Deficit

“Our focus has been on making the changes that we must make within the institution to be successful—whatever the marketplace is,” Dr. William N. Kelley, chief executive officer of the University of Pennsylvania Health System and dean of the Medical School, was saying. “While there are all kinds of external factors that have made matters difficult—and when they didn’t exist, we were going great —we can’t control the external world. But we can control our own organization. So we have got to do what it takes, with things we can control, to make sure that we’re functioning within the revenues that we have available.”

    Kelley made those remarks several weeks after the Health System, reeling from a $198 million operating loss in fiscal 1999, began eliminating 1,700 positions from its workforce. By late November it had already cut some 1,300 positions, and had drawn up plans to make the other 400 cuts by June 30, the end of the current fiscal year. Combined with the 1,100 positions eliminated this past May [“Gazetteer,” July/Aug], a total of 2,800 positions—approximately 20 percent of the Health System’s workforce—will have been eliminated over a period of 14 months. The financial-recovery plan is designed to save approximately $250 million over the next three years.
    “This is a particularly painful and difficult measure that we must take as part of our financial-recovery plan,” said Kelley in a message to the Health System’s members. But, he predicted, “We will emerge from this anxious time a stronger organization.” He emphasized that the system’s main goals—”to provide quality care; to educate the next generation of physician leaders; and to advance the world’s body of knowledge about health and human disease through cutting-edge research”—would not change.
    The Health System was established in 1993, and now has an operating budget of $1.9 billion. Just five years ago, it recorded a $123 million profit, putting it in a good position to expand and improve the infrastructure for quality. By almost every yardstick—patient care (the Hospital of the University of Pennsylvania has made U.S. News & World Report’s “Honor Roll” three years in a row and was ranked 10th in the nation last year); research and grants (second in the nation); the reputation of its School of Medicine (ranked third by U.S. News)—that quality did improve dramatically.
    But by 1997, the Health System was $16 million in the red, and in 1998 it posted an operating loss of $91 million. This past year, Moody’s Investor Service reported, the Health System spent $150 million of its cash reserves over an eight-month period, and was down to a relatively “modest” $406 million in reserve.
    Largely because of the external factors Kelley alluded to—including sharp cuts in Medicare payments, delayed and denied payments from insurers, and a lack of compensation from the state for indigent care—the Health System’s “revenue per unit of service was plummeting faster than we could [trim] the expenses per unit of service,” Kelley noted in an interview. (Another factor, in the view of some analysts, was the Health System’s rapid expansion and competition for physicians with the now-bankrupt Allegheny health system, though Kelley noted that it is “not possible to quantify” that aspect.) As a result, he said: “We had to get to a new level of aggressiveness to fix whatever we could fix within our control. We knew that we had a $177 million problem we had to solve in this fiscal year, and we’ve basically done that.”
    As Russell E. Palmer Hon’83, the former dean of the Wharton School who in July became chairman of the Health System’s trustees and, more recently, of a blue-ribbon task force appointed by the University’s trustees to assess the system’s future, put it: “We do not have the option of continuing to lose $200 million a year. We have to get our own house in order and we have to operate in the environment that we are operating in today on a profitable basis.”
    In addition to the loss of jobs and the blow to its pride, the Health System’s economic woes have led to lowered bond ratings for itself and for the University. Since February 1998, Moody’s has downgraded the Health System’s rating three times, from Aa3 to A3, and Penn’s rating twice, from Aa2 to A1. Both recently received “negative” outlooks, meaning that Moody’s believes it may have to lower their ratings again soon. In October, Moody’s stated that it “anticipates that the University’s operating performance will continue to be negatively affected by health-system performance for the next several years and that as a result, financial-resource growth will likely continue to lag that of peer institutions.”
    “I can see how they would come to that conclusion, because things have been consistently getting worse,” said Palmer. “But it is my belief that there is going to be a major turnaround operationally in the health-care system this year.”
    Kelley was equally optimistic. “We think that there’s a hell of a good shot at being better than break-even this year, and for sure next year,” he said. “The first quarter [of fiscal 2000] we’re in the black; our activity is up 71/₂ percent to date this year over last year; and last year it was up 71/₂ percent over the year before.
    “We’ve had a dramatic growth in volume,” he added, “and thank goodness, because if we were having to do what we’re doing with reduced volume in activity, we’d have an impossible problem. We’re seeing five times more patients than we saw in 1994. And we can’t teach without patients; we can’t do research without patients—so that’s critical to our mission.”
    Kelley pointed out that there were “no reductions in faculty,” although he acknowledged that, because of the high demand, “if anything, we need more.” But, he added: “We’re going to try to meet the demand by increased productivity rather than increased numbers. We’ve reduced very few nurses that were involved directly in patient care,” and only where more nurses were involved than necessary. Most of the cuts, he said, were in “management, senior management, other overhead areas and so on.” Of the first 1,100 positions eliminated in the first week of November, about 515 came in the form of layoffs; the rest were already vacant, due to retirements and other departures.
    The largest cut came at the Hospital of the University of Pennsylvania, which eliminated some 350 positions, including 160 through layoffs. Of the three other hospitals in the Health System, Pennsylvania Hospital eliminated 225 positions, 135 of them through layoffs; Presbyterian Medical Center eliminated 213 positions, 128 through layoffs; and Phoenixville Hospital eliminated 16, 10 through layoffs. Seventy-two Health System administrators were laid off, and another 42 positions were eliminated; 10 employees and three vacant positions from the Penn Care at Home network were cut, as were an estimated 150 clinical-practice positions. And over the next six months, some 400 positions in the Health System’s primary-care physician network and multi-specialty facility in Radnor, Pa. will be eliminated.
    Those remaining cuts, said Kelley, will all be “in the overhead area, not involving those directly involved in patient care,” and many will be made through attrition.
    “I really hate to see people get fired,” said Kelley. “For me that’s the hardest part. Many of these people have worked here for many years.” He added that a “fair and responsible decision-making process” was used to determine the layoffs, and said that the Health System is “committed to helping affected employees through the transition process.”
    In the end, said Kelley, “we’re going to be a better academic health system than we were. I’m sure we’ll make some mistakes, and we’ll do some things not so good, in which case we need to discover those and get them fixed—very fast. We must make sure that we maintain the quality that we have. We probably can’t continuously improve it at the rate we were, but hopefully, we’re making sure we maintain the baseline quality. Then, when we can afford to do more, we can gear back up and do it when we have the resources available.”
    The financial-recovery plan bears the imprint of the Hunter Group, a Florida-based consulting firm made up of senior health-care executives and clinicians, which was hired by the Health System in July. Although its final report is not out yet, the Hunter Group has been releasing its individual recommendations as they are completed.
    “I think they had some really good ideas and some good advice,” Kelley said. “We were able to reduce the numbers of employees better than we could have without them—easily. They’ve had a lot of experience with places like this; they know what the data is nationally; they know what works and what doesn’t work; they’ve seen best practices around the country. So they can tell us, ‘We’ve seen best practices where you can do things this way, so we’d recommend you do it that way.’
    “And as I’ve told the faculty on many occasions, ‘We expect to be the best at everything we do. When you look, however, at our efficiencies and productivities, we’re about at the median. Well, we wouldn’t accept being at the median in anything else, so we’re not going to accept being at the median in terms of productivity or efficiency or anything like that, either. We’re going to get our costs down below those of comparable institutions and be one of the best-value institutions in the country.”
    Asked if that could affect quality, Kelley noted that high productivity “by definition” includes high quality. “Quality is one of the variables that’s critical to it. So we’re talking productivity with the best possible quality.”
    Ironically, the Health System’s deficits mounted despite its soaring reputation for quality and record numbers of patients. During a recent panel discussion sponsored by Penn’s Leonard Davis Institute of Health Economics, U.S. Secretary of Health and Human Services Donna Shalala spoke bluntly about the national conundrum of wanting top-quality health care at a budget price.
    “We Americans seem resolved to wanting the best health-care system on the cheap,” said Shalala. “What we’ve gotten with managed care is not managed health care but managed costs. What we need to think about is how to delivery a quality system, one where health-care problems are avoided, where people go get care before it is too late. We have got to move our system toward getting quality.”
    But quality usually costs money, and ratcheting it up can only be done when times are flush. In the view of Dr. Mark V. Pauly, the Bendheim Professor and Chair of the Department of Health Care Systems, Kelley and the Health System also experienced some bad luck.
    “At the time the Health System was making aggressive steps to improve its reputation and its relative standing and the quality and value of its academic programs, the bad luck was that the external environment turned adverse,” he explained. That environment helped drive the Allegheny health system into bankruptcy in 1998, but not before its aggressive expansion fueled a spate of competitive bidding for physicians and facilities that probably exacerbated the economic problems of Penn’s Health System. “It’s the health-care version of cutthroat competition,” said Pauly. “It only takes one fool to make everybody else look like idiots.” The Health System also stretched itself economically when it took over Pennsylvania Hospital and Presbyterian Medical Center.
    As a result, those aggressive steps “turned out to be more harmful than if they had been more timid or inert,” said Pauly. “Bill Kelley’s fundamental ideal of doing something to improve the quality and reputation of the Health System and assure us of a flow of patients, in another environment would have paid off really well.” Instead, those external factors “pulled the rug out from under him.”
    “I’ve been working out there with a lot of other people around the country to get some of these external things fixed,” said Kelley, “because we’re in a tremendous crisis in American medicine today. A tremendous crisis. We’ve been the great contributors to progress and science and health care in this world. And that’s right from these academic medical centers. That’s at risk—and hopefully somebody will figure that out some day.”
    Clearly, the nation’s 126 teaching hospitals have been pummeled by economic forces beyond their control, and Penn is by no means the only one to have lost tens of millions of dollars in recent years. One national culprit is the federal Balanced Budget Act of 1997, which led to reductions in Medicare payments that “will cumulatively reduce the Health System’s revenues by $175 million by 2002,” according to a Health System statement. Medicare is the single biggest payer to teaching hospitals, notes Medical Industry Today, and “major urban areas where managed-care penetration is high are feeling its effect the earliest.” (In Philadelphia, the magazine says, “the HMO penetration has reached 44 percent.”)
    In an interview with University of Chicago Magazine, Dr. Ralph Muller, president and CEO of the University of Chicago Health System and chair-elect of the Association of American Medical Colleges, noted that between fiscal 1997 and fiscal 2001, the Balanced Budget Act targeted $43 billion worth of cuts in Medicare payments to the nation’s teaching hospitals. While that is fairly radical surgery in itself, Muller points out that after only two years, the plan is “running at the rate of saving nearly $65 billion by 2002,” and will thus “over-achieve its intended effect by almost 50 percent.”
    Congress, pointed out Kelley, recently passed a bill rescinding some of the Medicare cuts to academic medical centers that “will give us about $15 million over four years.” While he and others had been pushing for twice that amount, he said, “it’s a lot better than zero.”
    There are also a number of regional issues peculiar to the Philadelphia-area market, where three-quarters of the region’s 80 hospitals lost money last year. One is that there are, for all intents and purposes, just two insurers—Aetna U.S. Health Care and Independence Blue Cross, which together handle some 80 percent of the health-care market.
    “If you have two big payers,” says Dr. David A. Asch GM’87 WG’89, executive director of the Leonard Davis Institute at Penn, “they’re really going to be able to call the shots to a large degree. And people do have to toe their line, so to speak. If health systems—providers—banded together to that degree, there would be accusations of monopoly power.” The bottom line, he says, is that insurance payments are “a day late and a dollar short. It’s sort of death by a thousand pinpricks from all sides.”
    “Insurance companies, probably because the employers that pay them have focused virtually entirely on cost, rarely have much interest in quality,” notes Kelley. “To get the quality improvement that we’re all trying to achieve takes major investments in infrastructure up front. You can’t make those major investments if you don’t have any money. And they’re not willing to pay for that.”
    “I think we should negotiate the best contracts we can,” says Palmer. “And I believe that we deserve more than the average because we are a very high-quality provider. And it would be a shame if health care in this country diminished in quality because someone out there—and I’m not looking at our two payers necessarily—said, ‘All we want in the United States is average health care for low prices.’”
    Kelley said that the Health System is working to improve its billing process to meet the “extremely high standards” imposed by the insurance companies, and expressed hope that it would be better and more efficient as a result. He also suggested that the insurers finally “seem to be working with us to make things better.”
    Teaching hospitals in general, noted Asch, “care for the sickest people, and generally engage in other socially worthwhile activities, both of which cost more than average.” Last year, the Health System claims, it provided $66 million in uncompensated care and some $40 million in under-compensated care. Since Philadelphia no longer has a public hospital system, Asch adds, “places like HUP are bearing a burden of indigent care that other academic health systems in other cities don’t have.” And while some states provide “substantial support” for indigent care, “Pennsylvania provides virtually nothing.”
    “We have been working hard with the health-care community in the state, along with the business community in Philadelphia, to get support for a substantial portion of the tobacco-settlement dollars in the state,” said Kelley. “That’s a $400 million pot of money annually that will be available for supporting health care in the state, and there seems to be uniform agreement—at least in this business community and this health-care community—that that is the best possible use of half those dollars.”
    The total bill for indigent care in the state is “about $700 million a year,” he pointed out, “so $200 million isn’t the total answer. But it gets us started in that direction.”
    Asch also argues that, on the whole (and apart from Penn), “there aren’t strong, big employers in this area that are really focused on or interested in health care.” Unlike, say, Detroit, where the United Auto Workers Union pressures employers to “pay top dollar” for high-quality employee health care, employers in the Philadelphia area “are bottom-fishing” and “paying the lowest prices, in general.”
    Finally, he says, there is an “intensively competitive academic health-system environment, in that there are probably more academic health-system beds per capita here than anyplace else.”
    For consumers and researchers and medical students, the advantages of linking health systems to medical schools and universities are obvious. “We all believe programmatically that there are important synergies to be gained by linking them,” Asch notes, “because the clinical programs become the laboratories—not just for the research but for the educational programs. The people who come to Penn for clinical care choose it in part because they know that with the academic programs comes what they believe to be a higher quality.”
    Although Kelley and his $1.2 million salary have taken a few hits in the press, he has made it clear that he has no plans to step down. And according to Asch, he has the support of the faculty as well as of the University administration:
    “I believe that medical-school faculty, on the whole, are very strongly behind Bill Kelley—whereas in the same set of circumstances you might imagine that he’d be an easy target for blame. Quite the contrary—I think people really are looking to him for continued leadership.”
    “The faculty have really all pulled together,” said Kelley. “This couldn’t have been done without every single faculty member and every faculty leader and chair pulling together and saying, ‘Let’s get this done.’”
    “As we look at this entire situation,” said Russell Palmer, “I would certainly agree with those that say we have major turnaround to effect, and that we have a lot of work ahead of us. But at the same time that we’re looking at that, we should also look at the tremendous strides that we have made as an academic medical institution. No one in the United States has accomplished more academically in the last several years than the University of Pennsylvania Health System under Bill Kelley’s leadership. And we should not lose sight of the many accomplishments that we should be very proud of.”
    Mark Pauly offers what he calls a “philosophical take” on the whole issue. “With the movement to market in health care, you need some bankruptcies and disasters to discipline [the players]. In that sense, it may be salutary. I just wish it hadn’t been here.”
    Having a health system, he added, “is a much more risky business than universities are used to.”