The structure and scope of the healthcare industry continues to change in response to healthcare reform and general market trends. One visible result of these changes is that hospitals are merging and independent practices are being acquired or forming associations with increasing frequency. According to Health Affairs, over 75 percent of all United States metropolitan statistical areas have experienced enough hospital merger activity to be considered "highly consolidated."1 From 2000 to 2012, the number of independent physicians in the U.S. dropped from 57 to 39 percent.2

Hospitals and practices are driven to consolidate for several reasons, including increased stability, additional negotiating power and wider distribution of costs. As integrated care and population health is emphasized, risks shifts to providers, which incentivizes the pooling of assets. Accordingly, consolidation naturally follows a push for more clinically integrated networks.

A state's healthcare spending, specifically Medicaid, represents a significant portion of its budget — on average, 15 percent of total state expenditure. The cost of care for Medicaid agencies and commercial payers varies considerably by provider. Often, large practices receive higher reimbursements than small practices by using their greater bargaining power in negotiations. Naturally, there are exceptions — unique specialists and/or providers that demonstrate above average value can sometimes receive above average reimbursements despite smaller sizes.

The intent of consolidation is lower cost and higher quality of care; however, its actual effect on quality is debated in current research. Martin Gaynor, PhD, chairman of the Health Care Cost Institute, testified before the Committee on Ways and Means in Congress, that "current research evidence…does not indicate a clear impact of consolidation on quality."3 What is certain is that after consolidation, at least in the short term, prices rise, conservatively by at least 3 percent, and anecdotally by up to 50 percent4 — affecting state and federal health plans, commercial insurers and patients.

What follows is an analysis of data from the Commonwealth of Massachusetts modeling the effects of small practice acquisition and the challenges facing small practices hoping to remain independent.

The impact of healthcare consolidation in the Commonwealth of Massachusetts

In 2010, MassHealth (Massachusetts' Medicaid program) accounted for approximately 36 percent of the state budget.5 Data from the Center for Health Information and Analysis6 shows that reimbursement rates differ by as much as 36 percent by provider group.7 Breaking the top 40 practices in the state into quartiles by per member per month reimbursement rates illustrates this disparity:

Consistent with national trends, the healthcare delivery system in Massachusetts is consolidating. When a practice acquires a relatively smaller practice, the smaller practice's reimbursements immediately increase to match those of the acquirer, at least until contracts can be renegotiated. Therefore, after an acquisition, the overall cost to the system of payers grows as higher rates are applied to a larger pool of providers.

For example, Harrington Physician Organization has 50 physicians and an average PMPM rate of $314.64, while Partners Community HealthCare has 6,000 physicians and a $443.20 rate. If Partners acquired Harrington, and Harrington's prices increased by $128.58 to match Partners' prices, the total annual cost increase for payers would approach $24 million.

The table below aggregates similar scenarios and illustrates cost increase caused by acquisitions of 5 to 25 percent of practices in the lowest quartile.

Variation in pricing across practices presents a potential for considerable increases in cost. If 25 percent of the smallest practices in Massachusetts were acquired by organizations in the top quartile, the annual cost increase to the system would be at least $87 million.8

Small practices face financial pressure to join larger practices

Hospitals, health systems and independent practices are motivated to consolidate to mitigate financial hardship, increase stability, increase buying and negotiating power and distribute costs. The Medicare Payment Advisory Commission explained to Congress that "current payment disparities [have] created incentives for hospitals to buy physician practices."9 The biggest incentive for smaller practices to welcome acquisition is financial. With reimbursement rates decreasing and overhead increasing, independent practices and small physician groups with little market influence are struggling to find cost-effective ways to adjust to legislation changes.

Specific reasons for consolidation:

One-time technology costs. Initial electronic health record implementations (and 2^nd generation EHR reimplementations) and initiatives required to achieve meaningful use incentives can be costly. The incentive programs offers eligible physicians maximum payments of $44,000 and $63,750, for Medicare and Medicaid programs, respectively.10 Unfortunately, these amounts often do not completely cover a practice's additional cost.

Investments of time and resources during and beyond the transition process are necessary to maximize the benefits of proper EHR usage and conquer any initial productivity dip. Large organizations have a greater investment capacity to mold the EHR into constructive data, while small practices often are unable to leverage sufficient resources. Instead of capitalizing on the powerful analysis of data, they are left with unused information and inefficiency.

ACO, quality and P4P management. In the transition away from fee-for-service to quality-based models, health plans are exploring pay-for-performance models to reward treatment quality rather than procedure volume. However, P4P is more suited to large practices and integrated systems that can provide the resources and infrastructure necessary to implement an analytics and change management program to manage care and track performance data.11

Best practice knowledge and implementation. Maneuvering best practices research and applying findings can be a labyrinth for a single provider to navigate. Conversely, a hospital or health system is able to centralize resources and fund outside help to master and implement best practices.

Malpractice insurance. Despite a modest decline in average malpractice premiums in 2012, malpractice insurance is a major concern for physicians. Depending on state and specialty, rates vary from $2,500 to over $200,000.12 An employed physician is shielded in part from this burden, as the employer generally provides basic malpractice insurance and access to legal staff.

Work-life balance and stability. When a physician transitions from independence to a salaried position, what he or she loses in autonomy is gained in stability. A 2011 Merritt Hawkins' study found that "personal time" and "lifestyle" were among the most important factors for residents' employment decisions.13 Hospitals and health systems can facilitate a work-life balance by providing buffers from administrative costs, consistent (and often higher) salaries and increased flexibility.

Access to specialists and more effective referral programs. As a health system incorporates more specialists, the organization can direct referrals to internal specialists and away from unaffiliated practices, bolstering the health system's business while pinching the independent practice's patient pool.

In conclusion

Incentives and challenges in the healthcare industry are encouraging hospitals, health systems and small practices to move toward mergers, acquisitions and consolidation. In its address to Congress, the Medicare Payment Advisory Commission warned that the trend of hospital acquisition of physicians has been "driving up costs for the Medicare program and for beneficiaries."14

In order for small practices to maintain their size and independence, their most difficult challenges — financial viability in the face of technology transformation costs, quality improvement and population health management — must be addressed. In particular, independent practices need affordable or subsidized options for:

• Implementation of EHR and effective vendor agnostic analytics that support quality and cost improvement programs and empower the practice to exceed meaningful use and reach a level of maximum efficiency and productivity.
• Population health management and health information exchange tools to enrich a practice's data with more robust data and help improve the health of the entire patient population.

All things being equal, most small practices value independence and lifestyle and want to stay small. However, the pressures of high cost technology, increased accountability for care efficiency and a stable (and higher) salary are strong. Only with support in the form of low or no cost ways to increase efficiency and provide better, more innovative care, will small practices succeed in the current climate of consolidation and reform.

Greg Chittim is the director of Analytics and Performance Improvement at Arcadia Solutions. He has over a decade of experience in consulting and technology and has worked with payer and provider clients on technology strategy and implementations that drive greater care and efficiencies across the national healthcare system. Prior to his work at Arcadia, Mr. Chittim was a consultant and technical software project manager at Monitor Group, an international strategy consulting firm, building industry expertise with leading organizations in the software, hardware, pharmaceutical, biotech, financial services, and non-profit fields.