How nonprofit health systems can benefit from post-acute care partnerships

In recent years, many nonprofit health systems have transferred post-acute care assets to joint ventures (JVs) with for-profit partners, including home health, hospice and inpatient rehabilitation assets. It is incumbent on health system leaders who are pursuing such a strategy to take steps to maximize the benefits, however, which is possible only with an appropriately aligned partner and well-designed JV structure.

Selecting an aligned partner

Discipline is critical during the selection process. Pressure from external advisors or internal executives to “get a deal done” quickly can backfire, yielding the wrong partner and disadvantageous deal terms. Instead, the health system should deliberately complete the following steps to lay the foundation for future success in the transaction.

1 Identify the system’s needs clearly and precisely. This step requires securing detailed input from the following health system stakeholders:

• Discharge planners and hospitalists, regarding the specific commitments they would want from the post-acute provider to facilitate timely discharge and prevent unnecessary readmission
• Primary care providers and emergency department (ED) physicians, regarding what, if any, specific commitments they would expect to receive from the post-acute provider to assist in reducing unnecessary ED visits and avoidable admissions
• Value-based care and contracting leaders, regarding specific commitments from the post-acute provider to promote the health system’s successful performance in bundled payment or shared savings models spanning the acute and post-acute phases of care

In these discussions, it is critical that the stakeholders assume that the JV will operate on an electronic health record (EHR) that is distinct from that of the nonprofit health system. Therefore, commitments regarding EHR integration are critical. Failure to comprehensively assess EHR integration needs upfront will lead to operational and physician dissatisfaction and missed financial targets post-closing.

2 Develop a sufficiently detailed request for proposal (RFP). The RFP should not only present background on the health system and post-acute services to be joint-ventured, but also compel respondents to detail their track record relative to specific concerns identified and the commitments they would be willing to make in a potential transaction.

3 Apply internal stakeholder feedback. The health system should use standardized criteria derived from such feedback to evaluate each potential partner’s track record and commitments.

4 Keep multiple potential partners engaged in the selection process. This effort should continue until the preferred partner is identified and signs a letter of intent including detailed, precise commitments on price, the key needs described above and the terms discussed below. If negotiations become exclusive before this point, the health system will be at a disadvantage.

Engaging an investment bank or financial adviser is not necessary to run the process. Doing so tends to generate significant cost, and given the prospect of a lucrative success fee, an adviser can subconsciously (or consciously) subordinate the health system’s needs and focus on selecting the deal partner and agreeing to deal terms more likely to “get a deal done.” Moreover, financial advisers are aware that the potential for future work is much greater from a large for-profit provider of post-acute services than from a nonprofit health system.

An internal executive is likely to be just as capable of accurately identifying the major post-acute providers to be approached. An organized internal program manager working under the executive can move the process along efficiently, objectively and at low cost. He or she can, working in tandem with counsel, also coordinate due diligence.

Structure and capitalization

These types of JVs are typically structured as manager-managed limited liability companies (LLCs) and are treated as pass-through entities for tax purposes. The nonprofit will contribute the post-acute care assets to the LLC through a contribution agreement, which will specify the assets, disclose any encumbrances, address contingencies on closing (e.g., completion of due diligence and securing the governmental approvals described below) and delineate covenants on use and operation of the assets between signing and close. The nonprofit must ensure that none of the contributed assets were financed with outstanding tax-exempt bonds to avoid impermissible use of tax-exempt bond proceeds.

The for-profit will typically secure its equity stake in the JV via a cash contribution. If the agreed value of the health system’s contributed assets exceeds its agreed proportionate share of equity in the JV, the venture will distribute to the nonprofit that portion of contributed cash necessary to bring the value of its contributed assets to the desired portion of total equity. When applicable, this upfront dividend will enable the health system to more fully fund high-priority capital needs central to the system’s acute care operations.

Typical post-acute care joint venture (JV) transaction structure

Valuation

The parties must ensure that the negotiated valuation of the nonprofit’s contributed assets, and any in-kind assets that the for-profit might contribute, fall within fair market value range as determined by a reputable appraisal firm.

A rigorous valuation is indispensable for demonstrating compliance with federal and state fraud-and-abuse laws and restrictions governing private benefit, private inurement and distribution of nonprofit assets.

Governance rights

The nonprofit should retain a voting stake on the JV board that is no less than its proportion of contributed capital. Ideally, the nonprofit should seek a 50% vote on the board, even if it maintains less than 50% of the equity. Certain powers will be reserved to the for-profit partner to enable it to consolidate JV operations onto its financial statements, possibly including the right to unilaterally appoint and terminate the JV’s CEO. This consolidated accounting has the benefit of removing what was negative or at best anemic financial performance on post-acute care operations from the health system’s income statement, thereby eliminating a drag on meeting bond covenants.

Conversely, the nonprofit will want to reserve certain rights helpful to ensure that distributions it receives will not be deemed taxable income, which could include the JV’s adherence to the health system’s patient financial assistance policy.

The nonprofit will also want to reserve rights to ensure quality and access to care are maintained. This imperative, while always present given that the hospital will be discharging patients to the JV, assumes even greater importance when the JV is eventually cobranded with the health system.

Management services agreement

The for-profit partner or its affiliate will enter into a long-term management services agreement (MSA) with the JV to provide the support services required for effective operations. Given its greater scale, lower wage structure and more limited benefit package, the partner or affiliate can furnish these services at a lower cost than can the health system.

The MSA should comprehensively identify all support services required for effective operation of the JV, save for those listed in any transition services agreement with the health system (as described below). MSA services will include, among others, all billing, collection, information technology, financial, analytics, human resources, compliance, legal, regulatory, accreditation, purchasing and risk management services required for JV operation. They also typically include the electronic health record (EHR), IT support applications and any interface required with the health system’s EHR. The health system should insist on provisions in the JV operating agreement permitting its representatives on the JV board to unilaterally enforce the MSA. Changes to the MSA should require the approval of the health system’s representatives on the
JV board.

Compensation for the management services typically takes the form of reimbursement of direct expenses plus a fixed percentage of JV net revenue. To ensure incentives are aligned, a meaningful portion of the potential compensation should be placed at risk for meeting pre-established service commitments that were identified during the initial due diligence process undertaken when selecting a partner.

Critically, the parties must secure an independent appraisal documenting that the compensation terms fall within fair market value for the contracted services. This valuation, like that associated with the contribution agreement, will be critical in demonstrating compliance with federal and state fraud and abuse laws and ensuring that the JV margin is not inappropriately diverted to the management company.

Transition services agreement

Any transition support services the health system provides to the JV or management company should be memorialized in a transition services agreement. Such agreements are often used when the transaction will close prior to issuance of a new license and provider agreement to the JV.

During the interim period, the health system will continue to serve as licensee and operator, with all revenue, expenses and liabilities assumed by the JV. These agreements can also be used when the management company will be delayed in being able to provide specified support services (e.g., revenue cycle services, information technology support) for a finite period after closing and must rely on the health system to continue providing such support. The health system should be compensated for all such services.

Contingencies to close

Historically, divestiture of post-acute care assets to a JV has rarely required prior government review or approval. The occasional exception usually involves contribution of a pre-existing rehabilitation hospital. The transaction will rarely be significant enough to trigger a Hart-Scott-Rodino Act filing.\a Moreover, state statutes requiring prior review of transactions involving nonprofit assets have typically focused only on inpatient facilities. However, several states have begun expanding the scope of transactions subject to mandatory prior review. making it important for health system leaders to continue monitoring state legislation to identify and comply with possibly emergent prior notice and review requirements.

Footnote

a. The Hart-Scott-Rodino Act established such a filing process under the federal premerger notification program, designed to inform the FTC and the Department of Justice about pending large mergers and acquisitions (ftc.gov/enforcement/premerger-notification-program).

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Why health systems are pursuing post-acute care joint ventures

The trend in which nonprofit health systems are partnering with for-profit operators to deliver post-acute care stems, in part, from three factors.

 1 Margin compression. According to a recent survey by Kaufman Hall, the median operating margin for acute care hospitals in 2023 was approximately 1.9.^a Low operating margins force many health systems to make painful choices when allocating increasingly scarce capital. By the time the most pressing capital needs in the acute care segment are satisfied, there is little, if any, funding left to support highly valued post-acute care services.

2 Difficulty in delivering post-acute care cost effectively. It is difficult to furnish post-acute care services cost effectively within the expensive cost structure built around the acute care enterprise. As a result, post-acute care services become a drain on a health system’s already anemic bottom line.

3 Lack of core competencies. Delivering post-acute care requires unique management, human resources, IT, purchasing, quality oversight, revenue cycle payer contracting and workforce education, which are not optimally served by structures designed to support acute care operations.

Even so, health systems are reluctant to entirely divest themselves of post-acute care assets. They recognize that effective acute care operations increasingly depend on timely access to high-quality, cost-effective post-acute care. And they appreciate the critical role post-acute care services play in facilitating timely discharge, enhancing hospital throughput and avoiding unnecessary readmissions, thereby improving quality of care, patient satisfaction and the bottom line. When a health system shares risk with a payer for inpatient utilization, these concerns are magnified.

Under such circumstances, contributing post-acute care assets to a properly structured joint venture (JV) with an aligned partner offers an attractive middle ground. The health system maintains a meaningful role in ongoing governance and provision of post-acute care. By its governance role and the attendant contractual commitments, it can protect timely access to high-quality care for its patients, while being relieved of significant capital demands, and possibly securing an upfront payment in addition to periodic distributions.

Meanwhile, unencumbered by the health system’s high labor and overhead costs, the for-profit JV partner can significantly reduce operating costs to more competitive levels. With the benefits of scale and singular focus on post-acute care services, the for-profit partner can also provide effective support services at a lower cost. This capability will be particularly critical for two reasons:

• By maintaining lower-cost operations, the JV provider can minimize future capital calls and increase the frequency and amount of distributions to the health system, thereby enabling the latter to better meet other important capital needs.
• The health system will be able to participate in value-based care arrangements spanning the acute and post-acute setting more effectively.

From the for-profit partner’s perspective, collaboration with a health system is often preferable to establishing a new service independently for three reasons:

• The for-profit can expect to benefit from a pre-established referral base. It is reasonable to expect that, if access and quality remain high, referrals from the health system will remain stable or grow.
• To the extent the joint venture will be co-branded with the nonprofit health system, it will continue to enjoy the “halo effect” from the health system.
• In a jurisdiction with certificate-of-need requirements, investment in a pre-existing post-acute care provider represents a significantly faster, less-expensive path to market.

Footnote

Swanson, E., National Hospital Flash Report: February 2024, Kaufman Hall, Feb. 28, 2024.

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Labor and employment considerations involved in health system partnerships with for-profit post-acute care providers

Labor and employment considerations are critical to any deal involving delivery of post-acute care services between a health system and a for-profit management services provider. Health system employees who provide the post-acute care services and choose to stay with the health system will be rebadged to the joint venture (JV) or the affiliate of the for-profit entity. The challenge is that these employees would likely incur a significant reduction in their retirement and health benefits, and possibly a reduction in wage rates.

If the rebadged employees are represented, the health system must review its collective bargaining agreement to determine whether it is subject to notification and bargaining rights beyond those mandated by law. Even in the absence of greater contractual obligations, the health system would likely incur an obligation to engage in bargaining over the effects of the JV, with the union representing rebadged employees. In such bargaining, the union cannot block management’s decision to pursue the JV for the underlying services. The health system will, however, be obligated to meet and confer upon request of the union(s) to discuss the effect of the transition on the represented workforce. The union might ask that the health system, among other things, provide outplacement services to those who choose not to rebadge or give preference to those individuals should they apply for similar positions in the health system.

While likely obligated to recognize the union as the exclusive bargaining agent of any represented rebadged employees, the successor employer is not obligated to accept and adhere to the terms of the pre-existing collective bargaining agreement unless the successor employer agrees to do so or indicates to the represented employees that it will do so.^a  Therefore, the successor employer should be immediately and consistently clear in all communications that:

• It will impose its own initial terms and conditions of compensation and employment.
• These terms and conditions will be different from the health system’s collective bargaining agreement.
• It will then bargain in good faith with the union to negotiate mutually-agreeable contract terms.

It is important that the health system stay out of this process.

Regardless of whether the rebadged workforce is represented, the health system will likely need to provide notice to affected employees under federal and applicable state WARN [Worker Adjustment and Retraining Notification] Act provisions.^b  They will also need to consider whether specific personnel should be offered stay bonuses to maintain continuity of operations through closing and, if so, how the expense should be apportioned between the health system and for-profit partner. 

Regardless of legal obligations, the health system must ensure that the for-profit partner has a clear plan in place for immediate and ongoing consultation with affected employees during the transition. Hospital discharge planning staff should prepare for temporary alternative providers if the health system’s post-acute care service must operate at reduced volume during the transition due to employee turnover.

Footnotes

a.  This assumes that the joint venture will be majority owned by the for-profit entity rather than by the health system.
b. The U.S. Department of Labor defines the federal Warn Act’s purpose as helping to “ensure advance notice in cases of qualified plant closings and mass layoffs”(dol.gov/agencies/eta/layoffs/warn). Since the act’s passage, 13 states have enacted their own versions of the law that add to and/or modify its provisions.

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3 additional JV considerations to be reviewed

Pursuit of a post-acute care joint venture (JV) with a for-profit operator is a multifaceted undertaking, which means it will demand significant attention to detail by the health system leaders’ as they develop binding agreements for the JV. Three additional areas requiring such attention, in addition to the considerations described above, are branding, payer agreements and charity care.

1 Branding. If the parties intend to co-brand the joint venture with the health system, the specific cobranding terms or process by which they will be developed should be memorialized in the binding agreements. The system should maintain a veto right over any use of its name other than as specified in the agreement while extending a non-transferable right to co-brand as specified in the agreements. If contemplating cobranding, the health system should ensure that:

• Such branding conveys that the post-acute care service is owned by an entity distinct from the health system
• The system maintains sufficient authority to ensure the clinical quality of joint venture services and compliance of joint venture operations

2 Payer agreements. If the health system maintains separate payer contracts specific to the post-acute care services being divested, the parties can assess whether the contracts are assignable to the joint venture. This will rarely be the case. Most likely, the joint venture will not have the legal right to use the health system’s pre-existing payer contracts. Therefore, the JV will need to negotiate its own payer agreements prior to closing.

The agreements should also specify the obligation of the JV to participate in the Medicare and Medicaid programs and accept the referral of patients with such coverage.

3 Charity care. The JV operating agreement should clearly specify the JV’s obligation to treat uninsured patients or those qualifying for financial assistance under the health system’s policy. Presumably, the valuation accounted for the historical cost of care for these patients. The parties will then negotiate as to what level of contribution, if any, the health system must make in future years if the portion of operating expenses attributable to these patients exceeds historical levels.