Why does the state of North Carolina have its own hospital chain? That’s what lawmakers were trying to figure out in a meeting of the House Select Committee on State-owned Assets on September 22.
The issue at hand was the state’s interest in owning the University of North Carolina Health Care System (UNCHCS). Much of the discussion focused on Rex Health Care, a hospital system in Raleigh that contributes 32 percent of UNCHCS’s annual income. Rex is Wake County’s second largest hospital system and has been controlled by Chapel Hill-based UNCHCS since 2000. Its rival WakeMed Health and Hospitals, also in Wake County, offered to purchase Rex from UNC in May, but UNC has declined.
The UNC Health Care System was founded by an act of the General Assembly in 1998. The act combined UNC Hospitals, which are several UNC-related hospitals located in Chapel Hill, with the UNC School of Medicine’s clinical programs. It also gave the new system a three-part mission: research, teaching, and service. The system has since grown rapidly, acquiring a series of hospitals and clinics. In 2010, the system reported that it brought in $1.86 billion in revenue. I questioned the expansion of the system in an earlier article.
At the September 22 meeting, UNC Health Care CEO Bill Roper defended state ownership of Rex and, more broadly, an expanding health care system owned by the state. Perhaps sensing that the Republican-led committee would not look favorably on state-run health care for the sake of state-run health care, Roper argued that UNC Health Care was largely a means to an end. His case rested primarily on UNC Health Care’s contribution—mostly its financial contribution—to medical education.
In the question-and-answer section of Roper’s presentation, state representative Bill Brawley (R-Mecklenburg) asked Roper, “Do you necessarily have to own a hospital in order to train a physician?” Roper responded that no, the medical school doesn’t have to, and some medical schools don’t. However, many of those schools “are in much worse shape than we are.”
“I can promise you,” Roper continued, “if—God forbid—you force us to sell Rex we would definitely be back here next year asking for a whole lot more money from the state.”
According to Roper, Rex helps UNC medical education financially, both directly and indirectly. In terms of direct contributions, he said, “In the past 10 years, the only flow of funds has been from Rex to UNC—in the amount of $20 million.”
Twenty million dollars may sound substantial, but consider this: that’s an average of $2 million per year. WakeMed Health and Hospitals, the largest hospital chain in Raleigh, has offered to buy Rex for $750 million. Even without collecting interest on the $750 million, selling Rex would provide UNC with several centuries’ worth of the direct contributions it has been receiving from Rex.
If UNC sold Rex and created an endowment with the funds and received a return of, say, 10 percent interest (Harvard got an 11 percent return on its endowment in the economically sluggish year of 2010, for reference), it would get about $75 million per year in perpetuity. That’s about 38 times more in direct contributions than it is receiving now.
So, clearly, the direct financial contributions to UNC’s medical studies are insufficient as a reason to hold onto Rex.
The stronger—though less tangible—financial case for holding onto Rex comes from indirect contributions in the form of economies of scale. This concept, where applicable, explains why a larger operation can be more efficient, lowering prices and increasing profit per unit of output. Economies of scale can also give greater negotiating power. By having a larger organization, the argument goes, UNC’s health care system is able to streamline certain processes and leverage greater bargaining power in dealing with suppliers and insurance companies.
“We are a big hospital in a little town,” Roper said, referring to UNC Hospitals in Chapel Hill. Without owning other hospitals like Rex, Roper added, “we are subject to being buffeted about by anybody who wants to either cut the amount of funds that they [i.e. insurance companies] pay us … or raise the prices that we have to pay [i.e. to medical supply companies].”
To better understand this factor, I wrote Karen McCall, UNCHCS vice president of public affairs. “UNC HCS [sic] has a standing policy,” she explained via email, “that it will always pay the same amount for the same product for both hospitals, and that price will be based on the highest discount afforded to either hospital.” Thus, the hospital uses its size to insist on lower prices.
But not all expansions in all businesses entail vast efficiency improvements. Sometimes more just means more, and sometimes the improvements in efficiency are insufficient to justify expansion. Consider that in the case of UNC Health Care, selling Rex would mean about $75 million per year in revenue. In order for holding on to Rex to be a justifiable business case, then, the efficiencies realized by UNC Health Care as a result of owning Rex would have to be worth at least $75 million.
Given several days, Vice President McCall was unable to provide an estimate of the value of Rex in terms of its contribution to an economy of scale. This is not to speak ill of McCall, of course. It’s a difficult thing to measure, involving lots of assumptions that aren’t really knowable.
So, is Rex, owned by UNC, worth as much to UNC as Rex, converted to an endowment fund, would be? It turns out no one really knows.
But there is a broader question. Even if it can be proven that UNC’s ownership of Rex is the more lucrative option, does that justify the state’s owning a nearly $2 billion business to support one of its functions? That justification is perhaps analogous to NC State’s engineering department starting a large engineering firm to pay for lab equipment or UNC-Wilmington’s department of sociology and criminology starting a private security company to pay for statistical software packages. Should the Kenan-Flagler Business School at UNC-Chapel Hill start an investment banking corporation to cover its expenses as well?
The answer is assuredly “No.” Such operations are outside the boundaries of a university’s legitimate functions, primarily education. Competing in the private sector with private businesses is not one of these functions. Moreover, legitimate functions should be funded using legitimate means: taxes and fees. UNC’s ownership of Rex creates a disturbing precedent: government ownership of the means of production, a notion that has failed, often with catastrophic results, wherever it has been tried. Rex’s rather questionable contribution to UNC medical education is hardly an excuse for sliding down that unprofitable slippery slope.