Physician/Hospital Collaboration and Competition in Southern California November 14, 2007

1. Physician/Hospital Collaboration and Competition in Southern CaliforniaNovember 14, 2007 Eric Themm Senior Vice President Medical Development Specialists, Inc.

2. Topics For Discussion • Southern California Overview • Current Trends and Drivers of Physician/Hospital Collaboration • Approach to Evaluating/Considering Strategic Options • Case Studies • Takeaways

3. MDS: Active Areas of Work Troubled Hospital Assistance Strategic Planning With Financial Overlay and Risk Analysis: Strategic Response Regarding Physician Strategy for Hospitals and Systems Affiliation/Joint Venture Development and Implementation Valuation and Fairness Opinions (JVs, ED Call, Directorships, etc.) Foundation Model – 1206L Physician Needs (Shortages, Retirements, Part-timers)

4. Major Trends in Southern California • Ongoing challenges with escalating costs – operating, building, labor and living – Very expensive place to do business • Difficult reimbursement and payor mix challenges (uninsured, Medi-Cal) • LA County in crisis (e.g. MLK closure, ED backlogs). Private hospitals being affected (e.g. Downey, Centinela). Several in financial distress. More closures expected. • Hospital systems divesting (e.g. Tenet, CHW). Physician groups (e.g. Prime) are buying. • Highly competitive market with fragmented market share and challenges maintaining centers of excellence

5. Major Trends in Southern California • Proliferation of freestanding outpatient centers. Saturation and oversupply in some sub-regions. • Pace of new center development has slowed • BBA has affected imaging • Ownership restructuring occurring with hospitals offered a bigger piece of the pie in some instances • Physician group consolidation/growth and increase in market share. Physician market share increasing on O/P side. • Difficult for hospitals to recruit doctors. Kaiser-Permanente and large groups securing a high percentage of new recruits.

6. California Age Shift Source: OSHPD Annual Utilization Report of Hospitals 6

7. Inpatient Admissions per 1,000 Persons1981 - 2004 Per Thousand Source: The Lewin Group analysis of American Hospital Association Annual Survey data, 1981 – 2004, for community hospitals and US Census Bureau: State and County QuickFacts, 2004 population estimate data derived from Population Estimates, 2000 Census of Population and Housing 7

8. Total Inpatient Days in Community Hospitals1981 - 2004 Per Thousand Source: The Lewin Group analysis of American Hospital Association Annual Survey data, 1981 – 2004, for community hospitals. 8

9. Percentage Share of Inpatient vs. Outpatient Surgeries 1981 - 2004 InpatientSurgeries OutpatientSurgeries Source: The Lewin Group analysis of American Hospital Association Annual Survey data, 1981 – 2004, for community hospitals

10. Outpatient Surgical Market Share 1998 2003 2005 Source: FASA

11. Number of Freestanding Ambulatory Care Surgery Centers Source: Verispan 11

12. Further I/P Shifting to O/P Setting • Strong growth of ASCs projected for the next 5+ years • Other centers of excellence inevitable (Radiation Therapy, Cath Labs, Retail Mini-Clinics) • Lower cost setting and technology advances will continue to shift services to the ambulatory setting • Healthcare consumerism will increase the demand for care in settings that favor customer-focused services such as more flexible hours of operation (evening and weekend hours) and ease of access (close to home, easy parking, quick turnaround times) 12

13. Consumerism : Healthcare the Patient’s Way Private Rooms Documented Quality Convenient Access 13

14. Quality Expectations and Transparency Organizations working with IHI in many areas, including programs such as IMPACT Learning and Innovation Communities; initiatives such as Pursuing Perfection, Transforming Care at the Bedside, and the Safer Patients Initiative; IHI's global projects; and the work of IHI's Strategic Partners. AHRQ Indicators: Prevention, Inpatient, Pediatric, Patient Safety CalHospitalCompare.org Hospital Compare has quality measures on how often hospitals provide some of the recommended care to get the best results for most patients This site includes ratings for clinical care, patient safety, and patient experience for the 210 hospitals in California that have chosen to participate in this important voluntary project.  In August 2006, President Bush signed an Executive Order to help increase health care transparency by encouraging the adoption of health information technology standards, the provision of options that promote quality and efficiency in health, and that pricing and quality information be made publicly available 14

15. Leveling the Playing Field

16. What We Are Seeing: Physician Side Struggles with cost escalation & growing administrative burdens of practice management Shortage of PCPs (especially IMs) and growth of hospitalist models Continuing and growing participation in JVs – ASC, surgical hospitals, MOBs. Desire to supplement income and have more autonomy Erosion of solo practitioner model Quality of life/lifestyle = key for younger physicians Desire for state-of-the-art technology Increase in employment & participation in integrated models

17. Hospital Industry Dilemma • Historical inpatient focus achieved at the expense of developing an outpatient core competency • Lack of focus and expertise (jack of all trades, master of none) created an opening for single-specialty niche providers • Focused factories have provided a more efficient, service-oriented alternative • Hospitals have been slow to respond and embrace the changing landscape • Physicians view hospitals as IP operators and they have little confidence in their OP expertise • Dependence on external OP center operators to facilitate JV deals and manage centers 17

18. Common Hospital Strategic Questions • What outpatient services should we focus on? • Is it too late to develop a freestanding ambulatory surgery center? Imaging center? How can we recapture the market? • Should we cannibalize our own services in order to offer a physician joint venture? • Should we develop a satellite office building/ambulatory center? What services should we offer in a satellite center? • How creative can we get with joint ventures in order to anchor our specialists? • What should we do about specialty hospitals? • How do we prevent our best physicians from being our competitors? 18

19. The Hospital of the Future • Much greater dependence on dedicated OP Centers of Excellence (Focused Factories) competing on service, convenience and quality of care • Smaller IP acute setting surrounded by a portfolio of OP centers/services (e.g. Cancer Center, Cardiac and Vascular Center, Urgent Care Center) • As the portfolio of services grows and becomes more decentralized, providers must create an information-enabled environment to integrate care • Many of these centers will be JV’s requiring operating expertise and discipline 19

20. GAC Hospital Value Proposition? What’s the hospital’s value proposition if they’re not developing/managing the center? “Because of improvements in medical science, big hospitals are not needed for most treatments. You still need them for transplants, high-end oncology and very complex cardio thoracic operations, but that’s less than 10-15% of what is provided by hospitals. The rest of it can be provided by short-stay or outpatient facilities. We can do things a whole lot cheaper because we have fewer expenses and because we are a lot more efficient.” • James Thomas, CEO of Cirrus Health, “Traditional hospital feeling the squeeze from doctor-owned specialty clinics,” Los Angeles Times, 7/25/07. (In reference to a pending orthopedic hospital partnership) 20

21. Hospital-MD Joint-Venture Imperative Defensive Strategy: Creating joint-ventures to keep physicians from branching out independently. Partner or lose the business. “Everybody wants to create outpatient buildings that tether physicians to the hospital. They’re operationally more efficient. They provide a more-satisfying patient experience. They protect – or grow – market share. And they establish more harmonious relationships with doctors.” • Hospital Executive, “Now Entering the Outpatient Zone,” Modern Healthcare, 8/06. 21

22. Physician/Hospital Relations?

23. 23 23

26. What are Physician Alignment Options? • Service Line co–management • Service Line co-marketing • Service Line Clinical Services • 1206D • Gain Sharing • Straight and Per Click • Joint Ventures • 1206L • Employment (not CA) Low Risk Investment High Risk Investment 26

27. ASC Case Study • Hospital System in California – 2 regional hospitals within 8 miles • Affiliated, high volume surgical group interested in ASC • Hospital concerned about losing group. Better to have part of something than all of nothing. • Feasibility process to identify options, select optimal model and frame project (financials, structure, timeline)

28. Hospital Business Options (ASC) • Hospital Joint Ventures the ASC with Qualified Surgeons:Hospital and surgeons own and operate the ASC • Hospital, Surgeons and For Profit ASC Company Form Joint Venture:Hospital, surgeons and third party management company invest in ownership. Outside for-profit ASC company provides management • Hospital owns and operates the ASC under the Hospital License:Hospital operates the ASC without physician investors (Eliminated as an Option) • Surgeons form an Operating Company to Manage the Hospital ASC:Hospital owns the ASC which is operated under the hospital license. Operating company is formed as a physician venture in order to manage the ASC for the hospital

29. Option 1: Hospital Joint Ventures the ASC with Qualified Physicians • Freestanding ASC • Space and Equipment • Operations and Management Hospital 501(c)(3) 51%+ ownership Ownership Surgeons 49% or less Ownership • Terms • Free standing ASC owned and operated by a limited liability corporation • Qualified physicians must have a third of their income from surgery • Ownership percentages must be based on the investment amount, not the volume of surgeries or procedures

30. Option 1: Hospital Joint Ventures the ASC with Qualified Physicians Description Free standing ASC through a limited liability company joint venture formed between Hospital and qualified physicians. Joint venture operates the ASC and profits are divided according to investment/ownership percentages. Pros Involves interested group of surgeons in ownership of the ASC avoiding physician start up of separate venture or loss of volume to other competing ASCs Opportunity to attract Group physicians and patients Physician ownership involvement can lead to better efficiencies and cost effectiveness Cons Profitability would be greatly reduced from Hospital’s historical performance with resulting losses for all investors Management/performance by physician/hospital joint venture may not be as effective as an experienced for profit company- leading to investor disappointment

31. Option 2: Hospital, Surgeons and For Profit ASC Company Form JV ASC Management Company Surgeons Hospital VRC • Joint Venture • Space • Personnel • Equipment • Terms • Percentage ownership split between physicians, hospital and management company (e.g. 40%/40%/20%) • Negotiated management fees with for profit company • Profits distributed according to investment/ownership percentages

32. Option 2: Hospital, Surgeons and For Profit ASC Company Form JV Description Free standing ASC through a limited liability company joint venture formed between Hospital, qualified surgeons and for profit ASC company. Outside for profit company operates the ASC and profits are divided according to investment/ownership percentages. Pros Involves interested surgeons in ownership of the ASC preventing loss of volume to other competing ASCs Opportunity to attract physicians and patients Outside management and physician ownership involvement can lead to better efficiencies and cost effectiveness Cons Profitability would be greatly reduced from Hospital’s historical performance with resulting losses for all investors

33. Option 3: Physician Owned Operating Company Manages Hospital ASC Agreement for management of Hospital Outpatient ASC Ownership Hospital ASC Surgeons Physician Owed Operating Company • Terms • ASC location within 250 yards of hospital buildings • Physicians establish operating company to provide services at FMV to hospital owned ASC • Ownership interest and profits based on investment

34. Option 3: Physician Owned Operating Company Manages Hospital ASC Description ASC is run as a hospital outpatient department and managed by an operating company created by qualified surgeons. Joint venture services provided at fair market value and profits are divided according to investment/ownership percentages. Pros HOPD reimbursement is greater than freestanding rates Involves interested surgeons in the operating company ownership preventing loss of volume to other competing ASCs Opportunity to attract physicians and patients Physician ownership involvement can lead to better efficiencies and cost effectiveness Profitability for Hospital could be about half of historical performance based on prior contribution margin comparisons Retains flexibility to operate as hospital department if physicians elect not to invest Allows management operations, personnel policies similar to for profit company Cons Certain legal issues and restrictions: Limited distance from hospital (Medicare issue: 250 yards) Separate building address (union contract issue)

35. Key Volume and Financial Assumptions • Volume: new versus cannibalize • By service line • FFS vs MC • Volume assumption by physician • Major capital requirements • Expenses – staffing, supplies, purchased services, etc. • Other

36. Example 5 Year Volume Summary

37. Option 35 Year Profit and Loss Summary (Example)

38. Outcome • Hospital and physicians selected model • Potential short-term financial loss projected for Hospital but far less than probable outcome of physician exodus • Long-term partnership solidified (expectation) • 12-15 month timeline to implement

39. Surgical Hospital Case Study • Highly attractive and competitive market in CA • 30 orthopedic surgeons in 3 groups looking for ownership in a surgical hospital • Physicians anxious and aggressive • Two hospital competitors looking to beat each other to market

40. JV Expectations Improved Quality Stronger peer review Increased peer pressure O.R. start times Discharge times Physician behavior Core measure improvement Care standardization Utilization management Improved Cost Increased involvement in capital decisions Product standardization Formulary control Operations Impact Employee turnover Employee satisfaction Length of stay improvement Service line development Win/Win 40

41. Overview/Key Planning Assumptions • Dedicated, separately licensed orthopedic specialty hospital located on campus. • Approximately 60,000 square feet (dedicated use) with 4 O.R.s (5th shelled) and 32 private rooms. • Joint venture between Hospital and key orthopedic physicians. Estimate 30+ active physician users. • Spine/joint focus. Non-orthopedic services not envisioned at this time. • 1,500 cases projected in year 1, growing to 2,500 within 3 years. • 2 year window/timeline to complete project (facility operational in June of 2009). 41

42. Orthopedic Hospital Development Timeline and Staging 42 42

43. Services: In-House Versus Contracted 43 43

44. Core Elements of Orthopedic Hospital 44

45. Orthopedic Hospital Space Plan 45

46. Preliminary Start-Up Cost Estimate 46 46

47. Example JV Financial Projections 47

48. 60,000 to 65,000 sq. ft. should be adequate for the Orthopedic Hospital. This correlates to 1,875 to 2,031 sq. ft. per bed. The facility does not need to be as large as some freestanding orthopedic hospitals across the country because no ED is needed and other services (e.g. dietary, pharmacy) can be contracted with the main hospital. 32 beds (in private rooms) should be more than adequate in light of projected volume. Flexibility to “ramp up” capacity will ensure that bed availability will not be an issue. 4 O.R.s should be adequate for anticipated volume assuming that capacity in an O.R. is 700 to 1,000 surgeries per year (2,800 to 4,000 total surgeries) depending on the mix of inpatient to outpatient surgeries. 30+ physician users is optimal based on the experience of other surgical hospitals across the country. There are numerous examples of joint ventured specialty hospital across the country with the ownership “split” varying. For the facilities that we polled, physician ownership ranges from 20% to 50%. Facility completion should be feasible within 24 months or less. Preliminary costs for the facility are in the $15-20 million range. Preliminary Conclusions 48 48

49. Legal Considerations Choice of Entity Structure of JV Securities laws Stark Self-Referral Law Federal Anti-Kickback Statute Licensure, Provider Agreement 49

50. Securities Considerations Private placement memorandum Accredited investors only Residents of the state only 45 day offer period Can be extended at Hospital discretion Cash only from Physician Investors Hospital will not loan money to physicians to buy units 50