An Empire Contained

Virginia to South Carolina. Cradle to grave.

Only five years ago, Duke University Health System leaders envisioned a health care empire nearly without bounds, in both locale and service.

In 1998, even after the takeovers of Durham Regional and Raleigh Community Hospitals and initial investments in everything from infusion services to retirement homes, long-time DUHS chief executive officer Ralph Snyderman predicted the Health System had expanded to only 40 percent of its eventual size.

But ask Snyderman now about these ambitions, and he can only react at turns with self-assurance and chagrin.

"That was a very heady time," Snyderman says with a laugh. "One of the things that I will always say with a lot of pride is that we learned."

That lesson was certainly colored red, as Duke witnessed up close the high-cost, high-risk American health care market.

Although DUHS is by no means tiny--it employs more than 10,000 people and last year's revenues were about $1.3 billion--it has only shrunk in terms of facilities following 1998's sudden blitz, and the days of expansion are over.

In place of the old vision comes a new and perhaps more ambitious one. Meanwhile, the same criticisms remain.

So in 1991, when Duke held little more than the single, albeit highly-respected hospital, Snyderman set the official philosophy: Duke would become a managed care system extending throughout North Carolina, with every health care service an HMO could want.

Bolstering its position, Duke became part- and then full-owners of their own HMO, WellPath, and began pairing with hundreds of local physicians to gain valuable referrals.

Duke spotted the perfect opportunity to consolidate near home when, in the mid-'90s, Durham Regional Hospital hit tough financial times and began shopping for a potential partner. Duke stepped in and eventually won a 20-year lease for the troubled hospital from Durham County for a $7.1 million annual fee and the shouldering of $40 million in debt. The deal was finalized in June 1998.

Later that summer, Duke completed its three-tiered hospital system with the purchase of Raleigh Community Hospital for an estimated $200 million.

Meanwhile, DUHS had officially come into being as a financially and administratively separate entity from Duke University in July 1998, complete with its own board of trustees, financial assets and bond rating. "We essentially firewalled off the financial risk from the rest of the University, which is a smart thing to do," says Gordon Williams, DUHS vice president for administration.

Alongside this added power and agility, DUHS' financial interests expanded in nearly all directions: Chartwell Southeast, a drug infusion company; St. Joseph of the Pines, a home-care operation with services ranging from speech therapy to HIV/AIDS case management; A wellness center and senior care community in Fearrington Village near Chapel Hill; A heart facility in Robeson County; United Methodist Retirement Homes; Triangle Hospice, a provider for the terminally ill.

Frank Sloan, director of Duke's Center for Health Policy, Law and Management and a member of DUHS' board of directors since its inception, calls the strategy "vertical" integration, owning services at varied stages of care, as opposed to the purely "horizontal" integration of owning a plurality of coordinated hospitals.

"Functionally, the direction of health care is to be integrated," Snyderman says. "You need to have a continuity of care."

Ultimately, money was a central point of DUHS' horizontal and vertical investments. Gaining comprehensive services would make the Health System a more attractive partner for HMOs while safeguarding its well-established specialty and emergency care services through investment in more profitable clinical areas.

"We needed to stabilize our finances in a difficult economic environment and make sure that with the delivery of health care, we didn't go broke," Snyderman says. "Every business that we acquired... had to make it on its own."

This stringent requirement partially explains why nearly all of these ventures, including WellPath, either never materialized or have been sold off by DUHS.

ack in the late '90s, a casual observer might have called the University of Pennsylvania Health System a mirror image of DUHS--or maybe a remarkably similar bigger brother.

Like Duke, UPHS had ties to a nationally-renowned academic medical center and became heavily invested in regional hospitals and physician practices. At its height under visionary CEO William Kelley, the system partnered with 16 hospitals and countless local doctors from eastern Pennsylvania to Princeton, N.J., becoming a paragon for expansionary health systems.

Unfortunately, UPHS bought itself into a complete financial meltdown. Hurt by increased malpractice costs, reduced Medicare compensation and over-extension, the system bled more than $300 million in the two-year period ending the '90s.

The financially connected University of Pennsylvania was forced to scrap its promised extensive renovations of campus dormitories and dining halls, while the health system eventually eliminated 20 percent of its workforce and scrapped scores of investments.

"[Duke] made many of the mistakes [UPenn] did. We just didn't make them as badly," Sloan says.

The similarities are also personal--Kelley was Snyderman's first boss at Duke, and the two remain good friends.

"Bill Kelley's vision for Penn was a good, coherent vision, but he did it in a very aggressive fashion, without ever looking back and thinking, 'What if the creek rises?'" Snyderman says. "[DUHS] had a similar vision, but we right-sized it to what we thought that we could carry."

Because they constantly need to funnel profits into their educational and research missions and employ researching and teaching physicians who cannot see as many patients, academic medical centers are hit particularly hard by Medicare cutbacks and decreased compensation for services. The late '90s also saw financial failures in the medical wings of Georgetown and Stanford universities, and George Washington, Indiana, St. Louis and Tulane universities were all forced to sell their medical centers.

Many reasons help to explain the financial pressures on today's clinical market. Hospital administrators often blame the Balanced Budget Act of 1997, which reduced federal outlays to hospitals and contributions for Medicare. The Act has cost DUHS an estimated $200 million since it was passed.

HMOs and other insurance providers have successfully tied up the market as well. "The private payers are getting more aggressive," Sloan says.

This has led health care providers to give more and get less. "The amounts the Health System is paid for its clinical services has been steadily reduced over the last couple years," says Duncan Yaggy, chief planning officer for DUHS. "That has necessarily constrained our planning and expansion."

Overall costs for health care spiral upward, so more and more are forced into managed care or onto the long rolls of the uninsured. Meeting the needs of the latter, Duke's yearly cost for charity care is about $30 million and rising.

Meanwhile, Durham Regional quickly went from a crossing of the Rubicon to a potential Waterloo.

Hidden in the hospital's books was an accounting practice that overestimated its profits. The county rebuffed Duke's subsequent attempt to renegotiate the lease--DUHS was stuck, for 20 long years.

After adjusting for the error, Durham Regional has lost DUHS nearly $40 million since the acquisition--Snyderman terms it as once "a tremendous black hole for cash." Recent advances have erased the long-standing deficits, although two popular outpatient clinics were forced to close in February 2001.

WellPath was doing even worse in the competitive HMO market, losing about $12 million annually in 1999 and 2000 before being sold in late 2000.

"No one was managing the care," Snyderman says. "We learned that we did not want to be in the business of decreasing the amount of care that people had access to."

Varied reasons eventually checked many of Duke's other expansionary forays: The St. Joseph of the Pines joint venture was recently sold off, the UMRH deal fell through at the last moment and the Robeson County heart facility was rejected by the state under heavy opposition from area hospitals.

As of 2003, DUHS has been reduced to three hospitals, a network of physicians, a body of home care operations and a scattered few other ventures, outside of the growing Medical Center and numerous local specialty clinics--neither feast nor famine.

"We are much more cautious about partnerships now," Snyderman says. "I thought that we thought twice then, but I would think longer and harder now."

"The health care system in this country is screwed up beyond belief," Snyderman continues. Patching the holes will require innovative thinking and a deep understanding of patient care, he explains.

Despite DUHS' hardships, some might be surprised to hear of the tremendous advantage Duke has over other top medical schools in this domain.

"One of the downsides of an institution like Harvard is that a physician has to deal with a whole variety of different hospitals, which are not all necessarily under Harvard's control," explains Edward Buckley, associate dean of curriculum development in Duke's School of Medicine. "There's this problem of trying to get clinical exposure for their students. We don't have that problem."

From the second year on, Duke medical students are able to get extensive experience in varied areas of clinical care, all under Duke's control. "We have people in all three of [Duke's] hospitals, plus a whole host of outpatient settings, as well," Buckley says.

Owning an extensive health system also facilitates forward-thinking research by allowing scientists and physicians with patient exposure to collaborate, says Ross McKinney, vice dean of research for the Medical Center.

In particular, having a vertically integrated health system facilitates the investigation of how different stages of care affect well-being at another, allowing for research into models of health care that stress prevention rather than treatment. Preventive care has become a pet project of Snyderman's and an area primed for federal support.

"It's a transforming process for health care delivery," Snyderman explains.

With its expansion five years ago, Duke strengthened its status as one of the few in the nation to excel at medicine's Big Three: research, education and clinical care. This feat's value to Duke's name and power goes far in explaining the financial risk DUHS is willing to bear to hold on to a critical mass of clinical facilities.

However, completeness in American medicine comes at a high price. "We've just seen the greatest turnover of academic leadership in the history of [the School of Medicine]," says Williams, who notes the high cost of recent top hires.

At the same time, the Medical Center is heavily invested in facilities--more than $150 million is sunk into two Institute for Genome Sciences and Policy buildings, a new eye center and various other projects.

"[Investment in faculty and facilities] puts a lot of stress on our financial services," Williams says. But the stress is a necessary one, he adds, and the biggest risk is for clinical care to become a financial liability on research and education, as it did with UPenn.

"You can't put your entire financial enterprise at financial risk just to get all three done," Williams says.

Having a heart attack? A baby, perhaps? If you're a Durham resident, your only in-county option is Duke.

North Carolina Specialty Hospital--which offers eye and ear surgery, orthopedic services and plastic surgery--owns the only 14 hospital beds in Durham not owned by Duke. None are for acute care.

Forced to operate in a building constructed in 1926--complete with what CEO Rob Miner calls the state's oldest elevator still in use--the tiny hospital's past three applications to relocate to modern facilities near Durham Regional have all been rejected by the state because of potential duplication of services and heavy opposition from DUHS and the Durham County Board of Commissioners.

Their resistance stems from NCSH's alleged lack of charity care and potential damage to Durham Regional from competition with NCSH's specialties, each of which are among the few profitable health services Durham Regional relies on to support its whole operation. Kill Durham Regional's orthopedic services, they say, and the whole thing may come crashing down.

The indigent care claim has been much disputed. When the county commissioners first made their recommendation to the state on NCSH, current board chair Ellen Reckhow admits the board's opinion that NCSH did not provide charity care came solely from information provided by Durham Regional. Since then, new information provided by NCSH has convinced her otherwise.

In addition, an administrative law judge ruled in a non-binding opinion Jan. 1 that state regulators erred when they rejected NCSH's last proposal.

Such revelations fuel Miner's claim that Duke is actively trying to stifle competition on its home turf. "There's room for both of us," he says. "What we're asking for is just some friendly competition.... It improves patient quality and outcome. It gives a way to keep prices down."

Officials at DUHS see it a different way. "Our margin at Durham Regional has been stripped by multiple millions of dollars by this entity, which is essentially skimming a profitable line of business--pure and simple," Snyderman says.

Yaggy points out a nagging contradiction. "[NCSH] says it serves to have competition, and on the other hand say it's so small it would have no effect on Durham Regional," he says.

Snyderman denies there is a serious danger in Duke's control of almost all of Durham's health care. "The health care environment is very unique in that competition has not driven down prices. Duplicating more and more has created more and more," he says.

But he adds, "I would not be the one to advocate one company for a population."

For most, Durham's reliance on Duke health care has been positive.

"When Duke approached us about leasing Durham Regional... I was concerned about monopolistic control," Reckhow says. But her fears of rising prices and declining quality have proven unfounded, she says, noting those most concerned at the time of the merger, private physicians working out of Durham Regional, have been mostly satisfied with the result.

Pointing to several programs where Duke provides indigent care, Mary Ann Black, director of community service for DUHS and former county commissioner chair during both the Durham Regional merger and NCSH's first rejection in 1999, praises DUHS' involvement in the community.

Statistics support claims of improved Durham health--according to the North Carolina State Center for Health Statistics, the infant mortality rate for Durham County dropped 47 percent from 1998 to 2001, and only 9 percent statewide over the same period.

However, Duke's approach to NCSH does not serve to downplay the contention that with corporate size Duke acquired corporate tactics--especially in light of past accusations of anti-union activity by Duke toward Health System nurses, punctuated by a National Labor Relations Board investigation into six such charges, which were eventually dismissed in bargain agreements.

Like almost any biological organism, we've adapted to the environment," says Snyderman, who remains adamant that the vision has not changed, only its implementation. "We're out of the business of buying hospitals.... What we have found is that we need to focus on what we can do well."

DUHS is now concentrating most intensely on increasing efficiency and pursuing growth through specialty clinics and strategic partnerships, sacrificing verticality for solidity. "We're growing in terms of the depth and breadth and scope of our programs, but we're using the facilities that we currently have," Snyderman says. "We've done it without capital investment on our part."

As a result, he says DUHS' days of red ink may be over; the system is projecting a $30 million surplus for this fiscal year. "Will we have money? I don't know. I never take it for granted," he says. "We're right now in the budget for next year, and it's a grind."

Duke's increasingly cautionary attitude is partially born from an ominous health care future--major compensatory reductions from both Medicare and the state insurance plan are on the horizon.

"I'm worried about it," says Williams. "The stress on the clinical enterprise is huge in the current health care economy."

If there is one positive thing to be taken from the last five years, it's that DUHS managed to come out whole, despite making many of the same mistakes as others not so lucky, says Snyderman.

"We learned," he says. "Thank God, I think we're stronger now than we were then."