Gougers ‘R’ Us: How Private Equity is Gobbling Up Medical Care
Once a month, National Public Radio highlights medical horror stories for its series, Bill of the Month. The series is crowdsourced by patients who have been gouged by the medical industry, and they have swamped NPR with testimonies. Taken together, their accounts are a devastating indictment of the monopolization of the American medical industry.
A recent story highlighted Dr Naveen Khan, a 35-year-old radiologist from Southlake, Texas, who had his arm crushed by an all-terrain vehicle. An air ambulance took him to Fort Worth, Texas. The company promptly called him while he was in the hospital to let him know that the brief flight cost a total of $56,603. His insurer paid $11,972, which is about what the flight actually costs, while the air ambulance company billed Dr. Khan for the remaining $44,631, which he would have to pay out of pocket.
Dr. Khan’s bill is one among thousands of extortionate charges from air ambulances. Nationally, the average helicopter bill has now reached $40,000, according to a report by the Government Accountability Office. That is more than double what it was only nine years ago.
It would be tempting to conclude that higher prices are due to a shortage of helicopters or pilots to ferry wounded patients. In fact, the U.S. air-ambulance fleet has doubled in size over the past 15 years.
The laws of economics dictate that when demand is flat and supply increases substantially, prices should go down not up. What is preventing the laws of supply and demand from operating here?
The reason is the emergence of a national oligopoly. After a series of mergers, the air ambulance industry is highly concentrated and controlled by private equity groups. Two thirds of medical helicopters operating in 2015 belonged to three for-profit providers, according to the GAO.
Private equity have been active consolidating the industry, as they have so many other industries. In fact, researchers have argued that keeping hidden monopolies private is part of the attraction of private equity. The helicopter company that transported Dr. Khan was Air Medical Group Holdings, which is owned by the private equity group Kohlberg Kravis and Roberts (KKR). Other private equity groups are also active. American Securities LLC bought Air Methods for $2.5 billion in March 2017.
“It’s the same people who have bought out all the emergency room practices, who’ve bought out all the anesthesiology practices,” said James Gelfand, senior vice president of health policy for the ERISA Industry Committee. He added, “They have a business strategy of finding medical providers who have all the leverage, taking them out of network, and essentially putting a gun to the patient’s head.”
Gouging consumers with surprise bills is how private equity groups operate. According to an article in the Harvard Business Review, “Private equity firms have been buying and growing the specialties that generate a disproportionate share of surprise bills: emergency room physicians, hospitalists, anesthesiologists, and radiologists.”
A study by Stanford University shows that surprise billing has been rapidly rising from about a third of visits in 2010 to almost 43 percent in 2016. Much of this is driven by private equity groups, which are rolling up large parts of the medical industry.
These financial buyers have been extremely active. In 2018, the number of private equity deals reached almost 800, with a value of more than $100 billion. Their strategy consists of growing through acquisition or “roll-ups,” as they are called in the industry. According to a 2017 study in Health Affairs, 22 percent of markets for physicians are highly concentrated and have gotten that way via roll-up acquisitions that are below the threshold required to be reported to regulators. These have been called stealth roll-ups.
According to the American Enterprise Institute, “the biggest wagers in health-care services are being placed by private equity, which is chasing opportunities to roll up parts of the existing infrastructure.” In their view, “Cheap debt and ObamaCare’s regulatory framework almost guarantee more consolidation. That will mean less choice for consumers.”
Private equity groups have been busy buying free-standing emergency rooms, where prices can reach up to 22 times higher than at a physician’s office. They have been very active with mergers, buying orthopedic, ophthalmology, and gastroenterology practices. As humans treat pets like family members, private equity are even buying veterinary hospitals. Federal Trade Commissioner Rohit Chopra has called out roll-up transactions as an area of potential concern.
Medical care is unique. In an emergency situation, consumers do not shop around for choices, and they do not travel very far in search of better medical care. Controlling hospitals, ER rooms, and ambulance services can create local monopolies with the power to gouge. The medical industry is highly regulated with significant barriers to entry.
Professor Bruce Greenwald of Columbia Business School has noted that while most people think that monopolies tend to be national, they are often local: “Competitive advantages that lead to market dominance, either by a single company or by a small number of essentially equivalent firms, are much more likely to be found when the arena is local—bounded either geographically or in product space—than when it is large and scattered.” It is for this reason that private equity is so interested in rolling up local medical supply in many areas.
The term private equity is highly misleading. There is very little equity involved in most deals, and companies are generally loaded with debt. In the 1980s, the industry was more appropriately called the Leveraged Buyout (LBO) industry, due to the high degree of debt (leverage) involved in deals. When a wave of LBOs went bankrupt in the late 1980s and early 1990s, the industry rebranded and became known as “private equity.”
Pirate equity is more appropriate. It is an extractive industry that takes as much as possible from the companies it buys through endless fees and special dividends. Acquired companies are loaded with debt, which they can only pay down by hiking prices on customers and cutting costs. There is no new equity added in almost all acquired companies. Every time the term private equity is used, it obscures the true nature of the beast.
Unlike venture capital, which injects equity into companies and funds new ventures, or initial public offerings, which raise actual equity, private equity is purely extractive. Studies have shown that private equity leads to higher defaults, its claims to increase productivity are a sham, and it causes higher rates of job losses and firings in target companies as well as lower wages. (Unsurprisingly, industry-funded studies are much more sanguine.) But perhaps the most damning indictment of the private equity model is that their returns are overstated and their performance simply not as good as they lead investors to believe.
You do not need an MBA from Wharton to know that loading up companies with debt will lead to bankruptcy. Research shows that private equity funds acquire healthy firms and increase their probability of default by a factor of 10. They are the antithesis of conservative management.
Private equity groups have been behind most of the recent bankruptcies in local newspapers, retail, and grocery stores. In fact, analysis by FTI Consulting found that two thirds of the retailers that filed for Chapter 11 in 2016 and 2017 were leveraged buyouts. The pirate equity groups load debt onto the companies and dividend out the cash to themselves, which often leads to bankruptcy and a trail of job losses and underfunded pensions. Heads they win, tails the company, employees, and suppliers lose.
We have already started to see bankruptcies in pirate equity-backed medical companies. In a major stomach-churning investigation titled, “Overdoses, bedsores, broken bones: What happened when a private-equity firm sought to care for society’s most vulnerable,” the Washington Post chronicled the horrific practices that preceded the bankruptcy of ManorCare. In 2007, the Carlyle Group, a pirate equity group, bought ManorCare nursing homes for $6.1 billion and $4.8 billion of that was financed with debt.
Shortly after acquiring the company, the private equity group extracted $1.3 billion via a special dividend to recoup what meager equity it had put up to finance the deal. ManorCare was left with even more debt. As the pirate equity company cut costs, health violations skyrocketed. The debt load proved too heavy a burden to bear, and the company defaulted.
We have seen the same story in industry after industry where outcomes of care worsen and prices rise. A study of the education industry that examined 88 buyout deals found that not only did tuition costs rise when they were bought by pirate equity groups, but learning outcomes fell as well. Student debt also rose, as did defaults due to the substandard education that was offered. Everyone lost, except for the pirate equity groups, which extracted fees and dividends.
Leveraged buyout groups are not the only companies that have perfected the art of the roll up; they are merely the most skilled at it.
The kidney dialysis market has become a duopoly after a series of mergers in which DaVita and Fresenius engaged in a stealth roll-up. Approximately 490,000 Americans require dialysis treatment, and the two companies have 77 percent market share. Much like the rest of the American health care industry, DaVita has screwed the government and patients.
In 2014 and 2015, DaVita paid $895 million to settle whistleblower complaints that it had conspired to overcharge the U.S. government. In 2017, the company received subpoenas after being accused of steering poor dialysis patients to private insurers to inflate profits because DaVita was paid 10 times more through private insurance than Medicaid or Medicare.
We have seen the same local roll-ups and stealth consolidation in many other industries, such as funeral homes. Americans are not only gouged by roll-ups when they are sick but also when they die.
It is time to rein in private equity abuses across all sectors, but especially in the medical industry. A good start would be to eliminate the carried interest loophole that allows private equity bosses to see the income from their extraction treated as capital gains. (Capital gains should never apply, as they come from what Wall Street calls “Other People’s Money” and do not represent any investment of their own, only income for managing money for investors.)
So far, only Senator Elizabeth Warren has proposed any detailed reform. Many of the elements of her proposal are sensible and would reduce the appeal of debt and lower the probability of default. Yet until we see a comprehensive reform of pirate equity, we will continue to see extortionate medical bills, local monopolies in almost all areas of care, and higher default rates that harm patients.
Jonathan Tepper is a founder of Variant Perception, a macroeconomic research company, and co-author of The Myth of Capitalism: Monopolies and the Death of Competition.
This article was supported by the Ewing Marion Kauffman Foundation.