LOOKING INTO THE UC BUDGET -- Report #17 (e-mail version) by Charles Schwartz, Department of Physics, University of California Berkeley, CA 94720. 510-642-4427 June 1, 1995 SUMMARY The University's vast medical enterprises - its hospitals and outpatient clinics - are moving rapidly to expand their operating base and secure for themselves a substantial market share in California's rapidly changing health care industry. The UC Board of Regents is about to adopt unprecedented changes in their own ByLaws to accommodate a fast-track style of medical entrepreneurship. But little or no thought seems to have been given to the formidable risks which this challenging business venture poses for the rest of the University of California. BACKGROUND As an introduction to this subject, let me quote from the job description for a new Vice President position to be filled at UC headquarters: The UC sponsors the nation's largest health sciences education program (five schools of medicine; two each in nursing, dentistry, and public health; and 1 each in pharmacy, optometry, and veterinary medicine) with an overall enrollment of 12,000 students, including 4,000 medical residents. In 1992-93 the five schools of medicine generated about $440 million in federal research programs. In conjunction with the health sciences education programs, the University operates five academic medical centers at the Davis, Irvine, Los Angeles, San Diego, and San Francisco campuses which in total account for a permanent asset base (plant and equipment) of $1.8 billion. In 1993-94 total operations included 3,144 licensed beds, 103,997 admissions, 642,734 inpatient days, 1,662,647 outpatient visits, net revenues of $1.757 billion, and bottom-line gains of $92.264 million. The academic medical centers function in highly competitive health services markets with relatively high levels of managed care penetration, maximum pricing leverage exerted by large purchasing cooperatives, declining utilization rates, and accelerating integration and consolidation of providers. The five UC academic medical centers are pursuing broad ranging strategic and tactical clinical enterprise "business" responses aimed at securing sufficient market share to support their financial and academic requirements. Responsibilities of the Vice President--Clinical Services Development include providing oversight and coordination for the development of UC's clinical enterprise activities (mergers, acquisitions, partnerships, contracts, product line development, marketing, and related capital and other investment funding, etc.) ... Observing the Regents meetings over the past few years, it has often seemed to me that the best educational sessions were about the University's hospitals; and it seemed that this area of UC activities held more interest for many members of the Board than any other. There is the ancient attraction that medicine, its practice and research, has held especially for wealthy and powerful people in their old age. There is also the dynamism of today's health care industry, which excites many individuals, like the regents, who have had successful careers in business, law and politics. University medical schools and their teaching hospitals have long occupied a very comfortable niche, enjoying academic benefits from their base in a university, enjoying a variety of generous government supports, and at the same time enjoying financial benefits from their participation in the business of practicing medicine. All this is changing now. The enormous growth over the past decade - growth in research funding, growth in hospital construction, growth in the cost of health care for individuals and growth in the number of individuals claiming this service - has led to an acknowledged national health care crisis; and at present the determining drive has been taken by the commercial marketplace. With the collapse of government efforts at health care reform, profit-driven business competition is rampant and uncertainty is now the rule for providers and providees alike. It appears to be the consensus that university hospitals, if they are to survive, must enter this fiercely competitive market as active players. No longer can they sit and expect that patients will come to them. They must make business contracts with individual primary care physicians, physician groups, HMOs, health care conglomerates, whatever is out there signing up the supply of patients and potential patients ("covered lives" they are called in the new accountancy of managed care.) Thus, you read in the job description above about the dominion of the new UC Vice President--Clinical Services Development: "clinical enterprise activities (mergers, acquisitions, partnerships, contracts, product line development, marketing, and related capital and other investment funding, etc.)" How strange these words sound to the academic ear. One theme that arises repeatedly in the papers and talks given to the regents is the need for swift action - sign up those private medical practices to feed into UC's hospitals before some competitor grabs them. Another theme is the need for expert and bold leadership, knowledgable executives who are not averse to risk-taking. And a third is the need for more flexibility than the current UC system allows in setting compensation levels for effective medical practitioners and managers (rainmakers.) THE REGENTS START TO MOVE In January of this year the UC administration started to move. President Peltason announced a set of administrative initiatives - expansion of his own administrative staff, review of procedures at the systemwide level and with the Chancellor of each medical school campus, appointment of the new vice president, and a new advisory council - and the Board of Regents set up an Ad Hoc Committee to draft plans for expediting future regental action concerning UC's clinical enterprise activities. On May 4 I attended the last meeting of this Ad Hoc regents committee to see what they were up to. What I found was a small group (two regents and half a dozen administrators) who were all enthusiastic about launching a new streamlined enterprise. The existing Regents' Committee on Hospital Governance was to be given a new name (Committee on Health Services) and new powers (detailed below) and it was expected that regents serving on this committee would become very well informed and deeply involved in the business decisionmaking of the University's academic medical centers. The chief objective, so it seemed, was to cut away the existing impediments - many levels of administrative bureaucracy and a cumbersome system of regental review and approval - that keep the UC hospital directors from acting as the fast-changing marketplace demands. The recommended changes in Regents' ByLaw 12.7, as presented to the Board at their May 18 meeting, give these new powers to the Committee on Health Services: (a) Consider and recommend to the Board strategic plans for University clinical enterprise activities and for each academic medical center. (b) Consider and act upon ... matters related to business transactions affecting the clinical services of University academic medical centers and schools of health sciences ... (c) Consider and act upon the rates of compensation of University personnel holding staff positions in academic medical centers whose annual full-time salary rate is at or more than ... (d) Consider and recommend to the Board the academic medical center capital and operating budgets for each fiscal year. ... Paragraph (a) is unobjectionable. Paragraphs (b) and (c) provide for the desired speedy action, allowing this committee to bypass approval of certain decisions by the full Board (this is unprecedented). Paragraph (d) is a transfer of authority from the two other Regents' committees that currently are in charge of the University's operating and capital budgets (Committee on Finance, Committee on Grounds and Buildings.) As I listened to the discussion and read the documents at that May 4 meeting, I found a number of questions that troubled me. I had a certain perspective: This may all be well and good for the hospitals and medical schools, but what consequences might this have for the rest of the University? As far as I could see, such issues were not being considered and nobody was asking this sort of question. My first question was rather technical. What is the definition of the term "academic medical center"? Does this mean the same as "University hospital", the term in the old ByLaw 12.7 or the category "Teaching Hospital" used in UC's budget and accounting system? More likely, "academic medical centers" was meant to include not only the hospitals but also the clinical practice activities of the faculty and staff of the medical schools, which is partly inside the hospitals and partly elsewhere (speaking in terms of financial rather than physical location.) One ought to be clear in specifying the turf being carved out for this new and uniquely powerful Regents' committee. At the close of the May 4 meeting I tried to speak with Regent Peter Preuss, acting chair of the Ad Hoc Committee. He gave me his e-mail address and said I should send him my questions. I did so right away. His only response was, "Dear Charles, Thank you for your helpful comments.I have read them carefully." Then I attended the Regents' May 18 meeting and spoke briefly of these concerns, but got no response at all. Next I sent an e-mail inquiry to Dr. Cornelius Hopper, UC's Vice President for Health Affairs, and followed up with phone calls, requests for a meeting to discuss these questions, repeated e-mail -- but I have yet to hear any word from him. So let me proceed on the basis of what I do understand about UC budgets and finances to lay out a number of concerns and questions on this topic - ones that UC's leaders have either overlooked or decided to keep hidden from public discourse. BUDGET PRESSURE First, consider item (d) in the new Regents' ByLaw - the shift in budget authority to this new committee of the Regents. It is hard to see how this makes sense unless it covers the entire budget for the medical schools as well as the budgets for the teaching hospitals. The revenues into the "Medical School Fund Accounts" (over $400 million annually) come from the clinical practice of their faculty and staff; and this money is essential to both the instructional and research programs of the medical schools, providing the "practice plan" salary add-ons for faculty and also providing for "program enrichment." I do not see how a medical school dean could fashion an annual budget plan without combining all major sources of funding - state/university general funds, extramural research funds, and clinical practice income. Let's see some financial numbers for the Health Sciences sector of the University, combining all the schools of health sciences and the teaching hospitals. During the last fiscal year, 1993-94, total expenditures of current funds by the University of California (excluding the DOE laboratories) amounted to $7.080 billion, and the Health Sciences sector of the University accounted for $3.205 billion of that, or 45%. If one counts just the academic expenditures in the UC accounting system (Instruction, Research, Public Service, Academic Support and Teaching Hospitals), then the Health Sciences sector accounts for 59% of the total. And if one subtracts out the "Restricted" funds (mostly contracts and grants from extramural sources), thus looking at those academic expenditures over which the Regents have control, then the Health Sciences sector accounts for $2.527 billion or 62% of the UC total. When one looks at the changes that have taken place in recent years of severe budget shortages for the University, the distinction between these sectors becomes sharp indeed. Comparing 1993-94 data for expenditures of Unrestricted Current Funds with those for the year 1990-91, we find that the Health Sciences sector has grown by 12%, while the rest of UC's academic program (all "General Campus" expenditures) has been shrunk by 6%. [See my Report #16 for most of this data.] More "technical" questions: What does it mean for part of the Regents' annual budget to be approved through one committee and another part to come from a second committee? Will UC have two budgets or will the whole Board have to reconcile the two parts? How will the Legislature treat this bifurcated budget? The Regents' ByLaw for the Committee on Finance states that the budget they consider shall be prepared by the President of the University; but the new ByLaw for the Committee on Health Services does not say who will prepare their portion of the budget. Maybe none of this matters because the budget is really developed by the President and the Chancellors and then submitted to the Board, or to any of its committees, for rubber-stamping. But then, why bother at all with (d)? My sense, regardless of the answers to the technical questions raised above, is that what we have here is a significant shift of power within UC - a coup in which the financial priority of the medical sector, already very large in relation to the rest of the University, will become even greater. This new Regents' committee will be an informed, involved and powerful advocate for the medical sector of the University, something which no other academic sector has. The future of the medical sector is full of financial uncertainties and dangers, but so is the future of the rest of the University. By giving this added priority in the budget process to one sector, the Regents are unavoidably intensifying the budget pressures to be suffered by the rest of the university. RISKS OF THE MARKETPLACE Now put aside the details of the previous discussion and let's look at even bigger questions. UC's venture into the dynamic and competitive health care marketplace must raise the issue of financial risk. Maybe the bold new business ventures for UC's academic medical centers will all succeed, or maybe there will be some small setbacks that can be overcome. But what if there are substantial failures: What happens then? Who is at risk? That marketplace is populated by big and hungry sharks. Many small, medium sized, and big enterprises in commercial health care fail, go bankrupt or get gobbled up. How will UC compete? Some private health care conglomerates have large capital reserves and aggressive strategies to dominate the market. They may, as market forces dictate, seek to outbid their competitors, including UC, in attaining their objectives. Their corporate managers are expected to be smart, bold and successful. That's what they are paid (and often paid extravagantly) to do. That is what their investors expect them to do. Their financial backers are capitalists (public stockholders, private investors, banks and other lending institutions) who understand the risks they take with their investments and who anticipate handsome profits. How does UC fit into that economic jungle? Perhaps the regents and the UC administrators have forgotten that this institution is fundamentally different from a private business. I am not talking about philosophical values here; I am talking about, Whose money is on the gambling table? Let's spin some hardheaded scenarios. (I am a novice here. I wish professionals were doing this but where are they? This is what regents are supposed to be for: to bring business-world experience and common sense to the academic fuzzyheads.) Where will UC get the capital to go into the M&A (mergers and acquisitions) business? Apparently, some of this capital will come from the profits that UC hospitals have been accumulating in recent years and also from reserves in the clinical practice plans of the medical schools; external financing (loans) and "seller financing" are other sources mentioned in UC documents. What if one or more of UC's academic medical centers finds itself short of capital and falling behind in the local market competition - where will it turn for financial help? Will not the local Chancellor, or the President, be called upon for emergency funds - and where will that come from? What are the chances for failure? What is the probability in this turbulent market for one of UC's academic medical centers to lose a sustainable market share, to have the hospital operate in the red, to be left high and dry when government funding is cut beyond their worst expectations, to have their faculty forego their expected salaries, to be unable to meet their debt payments? And then multiply that probability by five. What happens when one of them fails? Are the bankruptcy courts available as a refuge to limit the damage? Will the other UC medical centers pitch in and help? Will the rest of the UC budget be available for a bail out? Will the Legislature be there? Short of catastrophic failure and aside from the annual budget pressures, there are other modes in which the medical centers' financial needs can severely impinge on the rest of UC. Each Chancellor (and the President) has a most cherished resource of discretionary funds (from contract and grant overhead, undesignated gifts, etc.) which are eagerly sought after by faculty members and departments throughout the university, especially in these tight budget times. When a medical center finds itself in hot water resulting from the unanticipated risks of these new business ventures, will not the Chancellor feel compelled to tilt the pot of discretionary funds in that direction? Among all those put at financial risk by the growing "clinical enterprise activities" are UC's undergraduate students (and their families), who already are being taxed, through escalating fees, to fill in the University's funding gap whenever Sacramento comes up short of the Regents' request. One could argue that even today student fees paid on the undergraduate campuses of UC are helping to subsidize the business expansions of the medical schools and their hospitals. Personally, I am retired and feel relatively secure; so my worrying about these risks being piled upon the rest of the University is somewhat abstract. For many others, who see their current and future careers tied in with UC's financial health, there are so many questions that demand to be addressed by the UC leadership. It is not sufficient for the President, Chancellors and regents to pass the buck - to say it is all due to the failures of the state and national governments and that they, the guardians of this public trust, have no option but to do as they are doing. Their obligation, morally and legally, is to act in a prudent fashion to protect the whole of the University. For them to go off half-cocked, as they appear to be doing in this venture, should not be tolerated. [The Regents are scheduled to vote on this ByLaw change at their June meeting.] ANY ALTERNATIVES ? One obvious idea, not original with me, is for UC to spin-off the whole medical enterprise: give it all over to a separate public corporation with its own legal and financial structure, its own charter and budget from the state, its own board of governors, and its own freedom of action. An amicable divorce to be arranged for mutual benefit. This ought to be thoroughly discussed; but nary a peep is heard in public. Perhaps one major obstacle to such a rational approach is the regents' pride.