History and Health Policy in the United States: Putting the Past Back In

12. Policy Implications of Hospital System Failures: The Allegheny Bankruptcy

During the late 1990s and early 2000s, the economy of the United States was rocked by a series of corporate accounting scandals and bankruptcies. Before there were Enron, Arthur Andersen, WorldCom, Tyco, and Global Crossing, however, there was Allegheny. Formally known as the Allegheny Health, Education , and Research Foundation, or more informally as AHERF, Allegheny filed for bankruptcy in U.S. Bankruptcy Court in Pittsburgh in July 1998. Filing papers cited $1.3 billion in debt owed to 65,000 creditors, making this the nation’s largest nonprofit healthcare bankruptcy. Allegheny’s growth, decline, and bankruptcy caused tremendous upheaval in both Pittsburgh (where AHERF’s corporate office, western Pennsylvania hospitals , and initial flagship teaching facility were located) and Philadelphia (the location of the eastern Pennsylvania hospitals directly affected by the bankruptcy filing). Hospitals repeatedly changed ownership, first among multiple nonprofit systems, and then in for-profit systems. Physician practices and medical researchers who were attracted to join Allegheny with large purchase prices and promises of new facilities and support were later jettisoned. Insurers entered into full-risk capitated contracts with Allegheny, only to have it go bankrupt without providing all of the contracted services. Suppliers and wholesalers continued to sell and deliver medical supplies after it failed to pay its bills. A handful of senior executives captured their pensions before the bankruptcy, but later repaid them—voluntarily or involuntarily. Employees of AHERF’s eastern operations, on the other hand, saw their pensions wiped out after the bankruptcy and then later restored by the Pension Benefit Guaranty Corporation. Finally, months before the bankruptcy, executives tapped into the Policy Implications of Hospital System Failures The Allegheny Bankruptcy Chapter 12 Lawton R. Burns and Alexandra P. Burns 273 system’s philanthropic funds (charitable endowments, restricted gifts) to cover operating costs.1 How could this have happened? The chronicle of the Allegheny bankruptcy illustrates how external policy and regulatory currents can exacerbate financial and managerial weaknesses within the firm and precipitate failure. In much of the literature about U.S. health care there is an almost romantic assumption that “regulation” and “market” are opposites—the former implying the heavy hand of government, the latter untrammeled and free. Of course, the market is not an unregulated or uninfluenced force. Both corporations and markets are regulated in numerous, complex ways, and they respond to corporate perceptions of public-policy changes. This is true, as we will show, for not-for-profit corporations such as Allegheny as well as for investor-owned firms. This chapter begins with a discussion of the causes of corporate bankruptcy and then describes how these forces led Allegheny to fail.2 The chapter then focuses on a new and important area: the public-policy relevance of the failure of large private (nonprofit) hospital systems such as Allegheny. While the empirical literature on corporate bankruptcy argues that such failures are the result of organization-specific factors, such as the long-term decline in the firm’s financial health, strategic errors, and managerial shortcomings , this chapter suggests that internal problems are strongly exacerbated by external policy and regulatory currents. The history of Allegheny is punctuated by the impacts of public-policy initiatives (at the federal, state, and municipal levels) on corporate bankruptcy, and the implications of corporate bankruptcy for public policy (at the state and municipal levels). This history illustrates the close interactions between public policy and the operation of private-sector markets and institutions. Causes of Corporate Bankruptcy Beginning in the late 1960s, much of the literature on the causes of corporate bankruptcy has focused on the internal financial health of the firm. Edward Altman (1968, 1993) and John Argenti (1976) identified a series of financial ratios that correlated with bankruptcy in firms. These included the firm’s cumulative profitability, return on assets, earnings stability, debt service (for example, cash flow to debt), short-term liquidity, capitalization, and total asset size. Research confirms that bankrupt hospitals are characterized by several years of negative margins, deteriorating equity positions, and low current ratios (Bazzoli and Cleverly 1994). Additional research on bankruptcies has identified some factors associated with poor financial measures. These include extremely high and low levels of 274 Lawton R. Burns and Alexandra P. Burns strategic initiative (that is, attempts to do too much or too little), poor accounting information or creative accounting, the strength and breadth of the...