How Wall Street used debt to drive hospitals to bankruptcy

Private equity (PE) firms have been snatching up hospitals and clinics at a record pace, promising enhanced technology, expanded facilities, and lower costs.

These takeovers were supposed to improve patient care—but in some cases, the result has proven to be catastrophic.

On Wednesday, the Senate launched a bipartisan investigation into the involvement of private equity firms in America's healthcare system. The probe follows last year's CBS News report on the dramatic close of Delaware County Memorial Hospital.

Last December, the prominent health facility that served a Philadelphia county for nearly a century unexpectedly shut its doors. A lengthy investigation with a massive money trail later revealed this was no ordinary closure.

As it turned out, the hospital was acquired in 2016 by Prospect Medical, a Los Angeles-based PE firm. Under the firm's ownership, the hospital lost its maternity ward, operating rooms, ICU, and emergency department—all in 2022.

Shortly after, the Pennsylvania Department of Health suspended the facility due to understaffing and “serious violations” of health code regulations.

But Delaware Country Memorial wasn’t the first health facility bankrupted by a PE firm. Prospect Medical owned 20 hospitals across six states—five of which had closed.

Prospect Medical blamed the closure on high labor costs, soaring inflation, and the financial strain caused by Covid. That didn't convince Rhode Island Attorney General Peter Neronha.

Neronha used state law to force Prospect Medical to hand over its finances, which is when he discovered that the investment firm took out a $1.12 billion loan in 2018.

The catch is that money wasn’t used to cover the hospital's expenses. Instead, Prospect Medical used debt to line the pockets of owners and shareholders.

In fact, the owners paid out a mind-boggling $457 million in shareholder dividends. Roughly $90 million of that went to Prospect Medical’s CEO. All while the hospital was under financial strain.

According to the financial statements, the company paid back the loan by selling land and buildings from hospitals to a real estate investment (REIT) trust for $1.386 billion. Prospect Medical then leased the hospitals back from the REIT.

The problem? Prospect Medical sold off its assets, meaning it no longer had equity and couldn’t use anything as collateral if it needed more funding.

Neronha drew a perfect analogy of what Prospect Medical’s senior brass did.

“It’d be like a homeowner going to a bank, taking out a $100,000 loan, and instead of using it to invest in their property or pay for their kids to go to college, what they did was they just basically stuck it in their pockets as cash.”

The scale of private hospital buyouts

Private equity firms are significant yet largely under-the-radar players in healthcare, owning an increasingly large share of hospitals

According to research published by UC Berkeley’s School of Public Health, the total value of PE deals in healthcare peaked at $120 billion in 2019—having nearly tripled over the previous decade. The number of deals grew from 352 to 874 over the same period.

While the value of deals fell in 2020 due to Covid, the number of transactions increased to 937.

Researchers Richard M. Scheffler, Laura M. Alexander, and James R. Godwin said these figures probably underestimate the true scale of PE buyouts because “many deals are not reported or made public.”

The research also found that PE funds increasingly focus on the healthcare sector. In 2020, 18% of total reported PE buyouts were in healthcare—up from 12% a decade ago.

As of 2023, it’s estimated that PE firms own at least 386 hospitals, or 9% of all private hospitals in the country, according to a tracker from the Private Equity Stakeholder Project.

These firms also reportedly own 30% of all for-profit hospitals.

Private takeovers are good for business— but not as much for patients

Some experts say private equity buyouts can make hospitals more cost-effective. But that usually comes at the expense of patients.

“Patients, healthcare providers, and policymakers are concerned about what the short-term private equity financial incentives are and how they might shortchange patients, result in consolidation in the healthcare markets, increase care costs, and perhaps worsen patient outcomes,” said Rachel M. Werner, a medical doctor and executive director at the University of Pennsylvania’s Leonard David Institute of Health Economics.

The problem is that PE firms—and this isn’t limited to healthcare—are increasingly taking on more debt to boost their returns—which is becoming expensive.

As Bloomberg recently reported, PE firms are raising cash with interest payments of up to 19% to lure investors.

“If the value of the fund drops, for example, you’re looking at a margin call situation,” said Jason Meklinsky, chief revenue and strategy officer at Socium Fund Services. “It would be like a volcano meets a tornado.”

For this and other reasons, “Private equity may not be well suited to this kind of industry, which is just riddled with imperfections,” according to Atul Gupta, an assistant professor of healthcare management at the University of Pennsylvania’s Wharton School.

Nevertheless, Gupta acknowledged that PE can negotiate higher prices and increase hospital revenues. This may not be a win-win scenario for patients, though.

While PE funds have a fairly solid track record in the healthcare sector, a recent review published in the medical research journal The BMJ found that private takeover usually increases patient costs.

“Our most unequivocal evidence is that private equity is associated with increased costs,” says Alexander Borsa, a Ph.D. candidate at Columbia University.