Kh 110815 union county work session v7

Union County

Union County Work Session
Overview of Long Term Lease of CMC-Union

Monroe, North Carolina / August 15, 2011

Copyright 2011 Kaufman, Hall & Associates, Inc. All rights reserved.
Copyright 2011 Kaufman, Hall & Associates, Inc. All rights reserved. 1

Union County

Topics for Discussion
• Healthcare Industry Update
• Overview of Current Lease
• Development of CMC-Union During Current Lease
• Review of County’s Stated Goals and Objectives
• Summary of Proposed Lease Terms
• Observations


Union County

Healthcare Industry Update


Union County

We Are in a Period of Tremendous Challenge
for Healthcare Providers
• Declining volumes
• Deteriorating payor mix
• Compromised financial performance and position
• Increased competitive pressures
• A physician market “free for all”
• A large capital appetite, but more limited/ difficult capital access
• Uncertain impact of reform


Union County

Feeling Squeezed Even Before the Impact of Healthcare Reform
Reimbursement Bond covenants
Pressures and RAC/ Investment losses
Short Stay Issues

Physician shortages/
recruitment/ retention/ Capital access/ cost
employment and the need to fund
growth strategies
Increasingly
competitive markets Pension funding

Specialty hospital/ Payor mix
ambulatory niche Impact on operating cash
flow and balance sheet stability? deterioration with rising
competition bad debt and charity

Equipment
Aging Infrastructure replacement/ new
Information technology needs technology


Union County

National Healthcare Point of View
1. Healthcare is rapidly moving from a post-Medicare business
model to a post-reform business model
2. Reimbursement will decline over time either on a “relative”
or a “real” basis
3. Reimbursement mechanisms will migrate away from
activity-based approaches towards those that reward quality
and cost effectiveness
4. The hospital sector will consolidate significantly and size
and scale matter
5. The basic relationships and care model between hospitals,
doctors, and patients will change dramatically
6. Technology will become a major disruptive change agent in
healthcare as it has been in other industries


Union County

New Core Competencies Will Be Required
Integration Attributes Key Characteristics of the Best Prepared
A highly aligned medical staff characterized by shared goals, outcomes-based
Physician/ Hospital Integration contractual arrangements, significant planning input, and adequately represented in
organizational governance
Care Coordination/ Management Use of care coordination tools and processes by an empowered and integrated
Capability workforce to meet performance goals that are regularly measured and reported
An IT platform that supports clinical decision making, information management, facile
Information Systems
communications, and access by all stakeholders (physicians, patients, administration)
Sophistication
to proper treatment and strategic decision making
A right-sized organization-wide cost structure, highlighted by appropriate levels of
Cost Management staffing, capital spending, overhead support, and supply chain costs; constantly
reviewed based on comparative peer group studies and benchmarks
A rational service distribution system that has accessible primary care and easy access
Service Distribution System
(both physically and through referrals) across the care continuum, delivered in
Effectiveness
contemporary facilities with contemporary equipment
Sufficient scale to attract competitive clinical and administrative talent, realize
Scale and Market Essentiality economies, drive marketplace innovation, and be an essential provider to health plans
and patients
Brand Identification Well recognized and respected, associated with high-quality and service excellence.
Maintaining strong relationships with payors and the ability to negotiate support for
Payor Relationships/ Contracts
“new era” business practices
Financial Strength/ Capital Strong appeal to capital markets through sustained operations, revenue growth, and
Capacity balance sheet strength


Union County

The Emerging Success Model in the New Era Will Likely Require…
• Compelling, market-based and physician driven strategy
• Scale and size to leverage fixed costs
• A strong position in the geographies served
• A solid, highly aligned physician platform
• A care, cost, and quality management culture
• Sophisticated IT and care management infrastructures
• Acute attention to operations, cost structure and business
portfolio management
• A well-managed balance sheet to weather volatility


Union County

The Expected Consolidation Trajectory: The Outlook Is for Increased
Consolidation Activity in the Hospital Industry
• Community hospitals that are unable to compete (financial
distress or lack of access to capital) are consolidating with
regional and national not-for-profit systems and for-profit entities
• Strong stand-alone community hospitals are partnering with
regional not-for-profit health systems
• Strong community hospitals are forming new not-for-profit health
systems with other strong community hospitals
• Regional not-for-profit systems are consolidating with other
regional not-for-profit systems
• National not-for-profit systems are consolidating with regional
and other national not-for-profit systems
• Large for-profit hospital management companies have
repositioned their portfolios and are poised for further acquisitions
• New private equity financing is entering the market

Union County

Industry Pressures Have Led to Hospital Consolidation Trends
Number of M&A transactions, 1995-2010 System hospitals – percentage

60%
58%
58%

56%

54%

52%
52%

50%
2000 2010

Primary drivers of • Financially distressed community hospitals
hospital consolidation in • Community hospitals requiring significant capital for
the past decade investments, but unable to access the capital necessary
to fund those projects

Sources: The Health Care M&A Deal Search, Irving Levin Associates, Inc., 1995-11 and American Hospital Association 2011.


Union County

Recent Consolidation Activity Supportive of Expected Trajectory

Quarterly Number of M&A Transactions, 2009 to Date

30 120 105

25 24 24 24
100
74
20 18 18 80
16 50
15 60
12

10 8 40

5 4
20

0
0
2009 2009 2009 2009 2010 2010 2010 2010 2011 2009 2010 2011
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Annualized*

Note: 2011 annualized data based on 46 total deals as of June 9, 2011.
Source: The Health Care M&A Deal Search Online, Irving Levin Associates, Inc.


Union County

Why Are Many Stand-Alone Community Hospitals Considering
Partners in Today’s Market?
1. Preservation of Access to Capital – The market is rewarding large
providers through access to low cost capital under flexible terms to
those that deliver on the promise of size and scale.

2. Insufficient Balance Sheets – Many independent hospital’s
balance sheets have been impaired due to the economic crisis –
and in tandem with limited capital access – these organizations are
no longer able to maintain their credit rating and fund competitive
capital needs.

3. Mitigation of Risk – Leaders of stand-alone community hospitals
are becoming increasingly concerned with industry risks, including
those related to healthcare reform, and their hospital’s ability to
maintain consistently high operating cash flow.


Union County

Why Are Strong Stand-Alone Community Hospitals Considering
Partners in Today’s Market? (continued)
4. Opportunity to Improve Quality – Larger organizations can afford
the significant investment of time, manpower, infrastructure, and
capital to truly drive improvement in the delivery of healthcare.

5. Expansion of the Platform for Physician Integration – Larger
organizations established successful physician employment models,
advanced information technology systems, and competitive physical
plants are generally better positioned realize the full potential of highly
integrated physician strategies.

6. Counter Payer Consolidation – The very strong position of major
insurers has, in some markets, aversely impacted independent
hospitals relative to larger systems which typically are in a better
position to negotiate fair compensation by virtue of their size and
market leverage.


Union County

Why Are Strong Stand-Alone Community Hospitals Considering
Partners in Today’s Market? (continued)
7. More Expansive Market Presence and Competitive Position –
Increasing access points and service area availability typically
leads to better branding and reputation within a service area

8. Service/ Program Development – The sharing of best practices
among multiple delivery sites enables organizations to learn quickly
from others successes

9. Information Technology – Larger organizations are better
positioned to leverage the fixed costs and infrastructure required for
sophisticated information technology platforms


Union County

The Outlook Is for Increased Consolidation Activity in the
Hospital Industry
• Community hospitals that are unable to compete (financial
distress or lack of access to capital) are consolidating with
regional and national not-for-profit systems and for-profit entities
• Strong stand-alone community hospitals are partnering with
regional not-for-profit health systems
• Strong community hospitals are forming new not-for-profit health
systems with other strong community hospitals
• Regional not-for-profit systems are consolidating with other
regional not-for-profit systems
• National not-for-profit systems are consolidating with regional and
other national not-for-profit systems
• Large for-profit hospital management companies have
repositioned their portfolios and are poised for further acquisitions
• New private equity financing is entering the market

Union County

Overview of Current Lease


Union County

Lease Term and Financial Considerations to Union County
• The current hospital lease began on August 27, 1995 and is set to
expire on August 26, 2020 (25 years from commencement date)
• Union Memorial Regional Medical Center, Inc. (currently doing
business as “CMC-Union”), a subsidiary of the Charlotte-
Mecklenburg Hospital Authority (d.b.a. “Carolinas HealthCare
System” or “CHS”) and Union County may renew for up to 9 years
upon mutual written agreement 180 days prior to lease expiration
• Union County receives an annual lease payment equal to the
greater of:
– $1.4 million; or
– 10% of operating cash flow plus 7.5% of investment income
• The annual rent payment is paid to the County in January of each
year and any additional funds due are paid after the close of that
fiscal year’s books


Union County

Recent Historical Lease Payments to Union County

Union County
Historical Lease Payments
2006 2007 2008 2009 2010
Minimum Payment - - $ 1,400,000 - -
10% of Operating Cash Flow $ 2,341,518 $ 2,134,777 - $2,809,175 $ 2,677,166
7.5% of Investment Income $ 490,954 $ 294,955 - $ 486,514 $ 479,164
Total $ 2,832,472 $ 2,429,732 $ 1,400,000 $ 3,295,689 $ 3,156,330


Union County

Financial Considerations to CHS
• CHS receives an annual Network Development Fee equal
to the greater of:
– $1.2 million; or
– 10% of operating cash flow plus 7.5% of investment income
• Should the Network Development Fee payable to CHS
reasonably pose a material financial risk to the hospital,
CHS may agree to abate the payment equal to an amount
the County agrees to abate its annual rental payment


Union County

Operating Surplus, Capital Approval and Governance
• CMC-Union is required to invest the hospital’s net operating
surplus in the facility for the provision of healthcare to the
citizens of Union County
– CHS cannot consolidate CMC-Union’s operating results
– CMC-Union borrows on it own credit
• CMC-Union is responsible for maintenance and any
improvements and additions to the hospital
– County maintains approval rights for any capital expenditure
exceeding $500,000
• A five-member Board of Directors governs the hospital; two
members are appointed by the Union County Commissioners and
three members are appointed by CHS.
• At lease termination, the County receives all hospital
property, improvements, long-term debt and monies


Union County

Development of CMC-Union During Current Lease


Union County

Service Lines and Clinical Services
The following service lines and clinical services have been added
at CMC-Union since 1995

• Cardiac rehabilitation • Advancements in diagnostic
and treatment technologies
• Diabetes center
• Palliative care
• Sleep center
• Waxhaw Health Pavilion
• Cancer center (pending)
• Family Practice rural • Union West Ambulatory
residency Surgery Center (pending)
• Wound Care center • Hospice of Union County
• Pain Management center acquisition by CHS
• Urgent care clinics


Union County

Facility Investments
During the current lease term, the facility improvements and additions
noted below have been completed at CMC-Union
• Outpatient Treatment Pavilion • Oncology services
• Women and children’s center • Materials management
renovation and expansion
• Coronary care and intensive
care units • Wound care center
• 24/7 emergency department • New Medical Office building
• Therapies expansion
• Emergency department
expansion and renovation • Information Technology
upgrades
• Day surgery and surgery
department expansion • Jesse Helms Nursing Center
• Union EMS base station
• Endoscopy department
• First Step renovation
• Cardiac diagnostic services


Union County

Medical Staff Advancement
• The CMC-Union Medical Staff has increased from 75 in
1995 to 475 as of the second quarter of 2011
• Growth has occurred in both specialists and primary
care physicians
• Specialties not currently represented include:
– Neurosurgery
– Endocrinology
– Psychiatry
– Thoracic surgery


Union County

Medical Staff Advancement (continued)

75 160 331 458 475
450 393 404
400
350
300 275
250
200
150 103
100 57 56 65 71
35 40
50
0
1995 1998 2008 2010 2Q 2011

Primary Care Specialists


Union County

CMC-Union Capital Spending Ratio as Percent of Total
Operating Revenue

$66M+


Union County

Future and Continued Development of CMC-Union
• Over the past 15+ years CMC-Union has noted significant growth in
its operations, medical staff and facilities

• In order to build on the momentum and growth created during the
current lease and transition towards a facility that provides higher
acuity treatments and tertiary-like services, CMC-Union will likely
need access to capital beyond what it can generate independently

• As noted in the industry update section, many community hospitals
faced with similar capital (and other operational) decisions are
determining to become member hospitals of larger health systems
to access the capital required to expand and the expertise needed
to navigate the healthcare industry’s uncertain future


Union County

Review of County’s Stated Goals and Objectives


Union County

Union County Goals and Objectives
At our work session in February, the County Commissioners articulated
the following as their primary goals and objectives for a “new” lease
regarding CMC-Union:
• Continuity in the delivery of healthcare within Union County
• Preservation of the existing clinical services in the County
• Additional services/ programs made available in the future in the
County, as clinically appropriate
• Continued high quality of care delivered to the hospital’s patients
• County should maintain ownership of the hospital
• Financial terms and conditions should benefit the County
• Term of lease should be long in nature and should not initially
exceed 50 years


Union County

Summary of Proposed Lease Amendment Terms


Union County

Financial Considerations
• On the following slides we have outlined our understanding to
the key terms under which CHS and Union County would
extend the existing lease agreement.

• If the County and CHS elect to move forward, these terms will
be incorporated into an Amended and Restated Lease
Agreement between the parties, which will be submitted to the
County Commissioners to consider.

• This agreement will further define these terms as well as
others that are typical in these agreements.

• It should be understood that these terms may change in the
Amended and Restated Lease Agreement as the document is
negotiated


Union County

• CHS will deliver to County, at closing, the amount of $54
million, which represents the agreed upon cash net of
outstanding indebtedness of the operating entity
– CHS will assume or extinguish the outstanding indebtedness of
the hospital
• The County will receive a total lease payment of $6.1 million
per annum for the initial 50-year lease extension (the Extended
Term), growing by 3% every five years should the lease be
renewed


Union County

Historical and Projected Lease Payments to Union County

Union County
Historical and Projected Lease Payments

2006 2007 2008 2009 2010 2012 & Beyond

Minimum Payment - - $ 1,400,000 - - -
10% of Operating Cash Flow $ 2,341,518 $ 2,134,777 - $2,809,175 $ 2,677,166 -
7.5% of Investment Income $ 490,954 $ 294,955 - $ 486,514 $ 479,164 -
Total Proposed Payment -- Operating Rent and Premium Payment - - - - - $ 6,100,000

Total $ 2,832,472 $ 2,429,732 $ 1,400,000 $ 3,295,689 $ 3,156,330 $ 6,100,000


Union County

• All of such funds – rent and the cash delivered at closing –
can be used by County in its sole discretion provided that
such payments cannot be used to compete with CHS
• The annual Operating Rent and Premium Payments will be
paid in full within the first 90 days of each calendar year
during the Extended Term


Union County

Put Option
• County will have the unilateral right within the first nine
months of each calendar year during the Extended Term to
require that CHS purchase CMC-Union for a purchase price to
be determined as of December 31 of such year (the Put Price)
• The initial Put Price will be an amount equal to $133 million
(the Initial Price) minus a portion of the lease payments that
have been paid by CHS according to a formula that will be
contained in the lease agreement.
– So long as North Carolina Certificate of Need laws regulate in-patient
beds (“CON laws”), the Initial Price will be increased annually by 2%;
upon the repeal of the CON laws, the Initial Price will not be further
increased

• The Put Price varies by year and will be included as a
schedule to the lease agreement
– From the Initial Price of $133 million the net Put Price declines to as low
as $128 million before increasing to $218 million by the end of the
Extended Term

Union County

Expiration
• Upon the expiration of the Extended Term of 50 years, CHS will
have the right to renew the Amended and Restated Lease
Agreement for an additional period of 25 years (the Renewal
Period)

• During the Renewal Period, the rights and obligations of the
parties will continue as set described except that the total lease
payment will increase to $6.283 million for the first year of the first
renewal period and will be increased by 3% every 5 years
thereafter during the Renewal Period


Union County

Expiration (continued)
If CHS does not elect to renew the Amended and Restated Lease Agreement upon
the expiration of the Extended Term, County will have the following two options:
1.Termination of Amended and Restated Lease Agreement
– Terminate the Amended and Restated Lease Agreement and require CHS to transfer
all CHS health-related operations and assets located in Union County (the Union
HealthCare Enterprise) to County and pay to CHS an amount equal to the Fair Value
of the Union HealthCare Enterprise on the termination date, minus the net Put Price
as of the termination date
– If County elects to require CHS to make this transfer to County, County would not
accept any direct or indirect financing assistance from a health system in terms of loan
guarantees, direct loans or other means to facilitate the transfer of the Union
HealthCare Enterprise to County
– In addition, County would agree, in writing, to operate all such assets for a transition
period of at least 5 years after the termination date with no indirect or direct
involvement in operations of such assets by another healthcare provider or operator
that is a competitor of CHS
– CHS agrees to provide any requested transition services at fair market value during
the transition period
– County may engage or hire a manager who is not a competitor of CHS to operate
Union County HealthCare Enterprise; or
2.Put Option – Exercise Put Option as previously outlined

Union County

Expiration (continued)
• Upon the expiration of the first 25-year Renewal Period, the County
and CHS will have the option to mutually agree to renew the Amended
and Restated Lease Agreement for one term of 25 years followed by
successive 10-year terms at the then current Operating Rent Rate to
be increased by 3% every 5 years thereafter
• If County and CHS do not mutually agree to any extension of the
Amended and Restated Lease Agreement, County will have the
following two options:
1. Termination of Amended and Restated Lease Agreement
– Upon at least 12 months prior written notice to CHS, terminate the
Amended and Restated Lease Agreement and require CHS to
transfer all Union HealthCare Enterprise to County and pay to CHS
an amount equal to the Fair Value of such assets on the termination
date minus the net Put Price as of the termination date
2. Put Option – exercise Put Option as previously outlined


Union County

Capital Investment
• During each 15-year period, CHS’s capital investments in the Union
HealthCare Enterprise will be no less than 75% of the capital spend at
other CHS facilities.
– This will be measured as the percentage of revenue spent at the Union
HealthCare Enterprise as compared to the percentage of revenue CHS
spends on capital for the entire system.
– However, the minimum capital spend will be limited to 75% of operating
margin of the Union HealthCare Enterprise
• Within 90 days after the end of each 15-year period during the
extended Term, CHS will submit a report to County summarizing the
investments made by CHS during the prior 15-year period
– CHS will have 5 years to make up its investment obligation if it is not met
for the 15 year periods.


Union County

Capital Investment (continued)
• CHS will use reasonable efforts to complete the CON approved
bed tower project and the deferred capital expenditures including,
but not limited to:
– PET/ CT scanners
– Second ambulatory surgery suite
– Waxhaw emergency department
– Will endeavor to determine the unmet needs and determine the
feasibility of providing new and improved healthcare services


Union County

Assumption of Liabilities
• CHS will assume all of the liabilities of Hospital, known and
unknown, fixed and contingent, accrued or pending, including,
but not limited to:
– The existing long-term debt, arising out of the ownership or
operation of CMC-Union, including outstanding bond debt. CHS
will take all steps necessary to permanently remove the County
from the outstanding bond debt.
– Professional liability
– Compliance related issues from prior years, if any.
– Medicare and Medicaid RAC arising during the term of the
Lease


Union County

Employee Commitments
• CHS will offer to employ each existing staff employee at
CMC-Union who meets CHS’s criteria for hiring comparable
employees and who CMC-Union recommends for hire at
CHS’s current compensation rates and benefits
• Within a reasonable time depending on benefit plan years
and third party approvals, if any, CHS will provide to all
CMC-Union employees the full array of CHS benefits at the
same levels of all other CHS employees of the CHS
• CHS commits to maintain staffing levels at levels
comparable to similar CHS facilities


Union County

Governance
• The existing Community Trustee Council will be converted to an
Advisory Council
– The Advisory Council will include one sitting member of the Union
County Commission and at least two Medical Staff representatives
– The Advisory Council will regularly advise CHS concerning policy
matters and the operation of CMC-Union
• CHS also commits to nominate and support approval of a resident
of Union County to the CHS Board of Commissioners
• During the first six years of the extended Term, CHS will
nominate, as the Union County member on the Board, one of the
three Union County residents who have been recommended to
CHS by the Advisory Council
– In addition, for the purposes of maintaining community involvement
and further integrating the strategic planning process in a unified
manner between CMC-Union and CHS, during the first six (6) years
of the extended Term, the Union County member of the Board will
have a seat on the CHS Strategic Planning Committee

Union County

Other Key Terms
• Financial Assistance: CMC-Union will continue to provide
financial assistance to patients consistent with CHS policies in
offering discounted and free care to patients
• Prisoner Care: CHS will provide care to patients from the Union
County Jail at a discount equal to the discount given by CMC-
Union to patients who do not have insurance
• Medical Staff: The Medical Staff President of CMC-Union will
have the same rights to attend all CHS Board of Commissioners
meetings as other CHS Medical Staff Presidents
– CHS will continue to complete Medical Staff needs assessments
and will use reasonable efforts to recruit and retain needed
physicians, including specialists, to Union County
• IT: CHS will ensure that CMC-Union will be on the overall
system IT platform


Union County

Other Key Terms (continued)
• Quality and Safety: CHS will ensure that CMC-Union and
Union Physicians Network, Inc. are included in all CHS system
wide quality, safety and clinical integration initiatives, clinical
integration including, but not limited to, accountable care
organizations
• Commitment to Maintain Services: For a period of not less
than five years of the Extended Term, CHS will continue to
provide all the material clinical services and programs currently
being provided by CMC-Union so long as appropriate levels of
clinical quality and patient safety can be maintained with
respect to each of such services
– Any deletion of such services and programs within such time
period will be based upon clinical quality and patient safety factors
and will require the approval of the CMC-Union Advisory Board
– The final lease document will define how the services offered at
CMC-Union will be determined after the initial 5-year period.


Union County

Other Key Terms (continued)

• Partnership Relations: County recognizes the importance
of supporting CHS as a lessee of County owned assets. As
such, County will:
• Ensure CHS is not excluded from any bidding of health related
services for County employees

• Make reasonable efforts to ensure that County employees are
encouraged to access to CMC-Union facilities and programs

• Support the investment and expansion of health facilities and
programs by CHS in Union County


Union County

Observations


Union County

Advantages of Proposed Lease Amendment
• While we recognize there are key terms that must be negotiated, Kaufman
Hall believes that there could be significant advantages to the proposed
Lease Amendment
– Perhaps chief among them is that it eliminates the going forward challenges
facing standalone hospitals
– Further, it should enhance the level of healthcare services available to the
citizens of Union County through a more complete and comprehensive clinical
and operational integration of CMC-Union with other healthcare providers in
the CHS healthcare system
– Finally, a robust healthcare system in Union County should provide relatively
high-paying jobs and also assist in attracting other employers to the county
• In addition, the proposed lease:
– Compels CHS to invest in the hospital and in Union County as incentives
between CHS and the County are aligned and CHS will consolidate the
hospital’s operations into its overall system financials
– Removes the County’s financial obligations relative to operating a hospital
– Provides a meaningful capital source to the County at the inception of the
lease as well as in years to come while allowing future Union County
Commissioners to monetize the asset at a predetermined price

Union County

Other Considerations
• While we believe there are substantial benefits to Union County in
proposed Lease Amendment, there are other factors that should be
carefully considered

• We believe the most significant issues relate to control
– Amending the existing lease will extend the period during which Union
County has little operating control of CMC Union

– If Union County decides not to renew the lease in the future, the amount
required to reimburse CHS for the value it has added during the term of
the lease is uncertain

• However, we believe these considerations should be balanced by the
fact that many counties across the country are seeking to separate
themselves from the burdens of operating a hospital and Union
County currently has little operating control over CMC Union in the
current lease


Kh 110815 union county work session v7

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