Insights from forum sponsor Kaufman, Hall & Associates, LLC

An increasing number of hospitals and health systems are pursuing management services agreements as a means to grow, leverage their fixed cost base, and gain access to expertise and other benefits of scale.

Management services agreements (MSAs) typically involve a contractual arrangement for a larger healthcare system to provide partial or full management services for a smaller organization. In some cases, organizations enter into service- or expertise-specific MSAs, such as for purchasing or clinical best practices.

The larger system commonly provides services in exchange for a negotiated fee. For example, the smaller entity may pay management fees equal to a percentage of annual operating revenue, plus incentives when it meets mutually agreed-upon performance goals. These agreements do not involve a change in ownership or governance and thus do not require state or federal regulatory approval.

In an environment of increasing cost pressure, with significant work already having gone into harvesting traditional cost reduction opportunities, MSAs offer an alternative means to maintain a strong financial position and/or address specific competency requirements. Numerous health systems have pursued MSAs to garner some of the financial and operational benefits of a partnership without having to engage in a more integrated arrangement.

Realizing the Benefits of MSAs

Both partners can benefit from an MSA. For the health system providing management services, such agreements offer a new revenue source and the chance to expand share in an existing market or to establish share in a new market. The economic risk is minimal because the health system does not assume debt or other liabilities of the managed organization. Typically the managing entity does not supply a cash infusion or a commitment to major capital projects.

For managed entities, MSAs may provide hitherto strong but smaller organizations the support of a larger, more sophisticated system, while allowing them to maintain governance autonomy and independence. Such agreements also may offer an opportunity for distressed hospitals to rebuild financial strength while ensuring the community asset remains under local control.

In either case, the managed entity benefits from access to the larger system’s operational expertise and other advantages of scale. For example, smaller organizations often are unable to support the level of specific management expertise that their MSA partner brings. An executive at a small hospital often must be a “jack of all trades” with a wide range of responsibilities, while the revenue base of larger systems allows for more specialization.

Both organizations in fact benefit from increased scale, which allows for improved efficiencies and savings in areas such as supply chain, sourcing, and procurement. Increased scale enables both entities to allocate costs across shared service areas, thereby achieving a lower cost per unit. Other potential joint benefits include the ability to:

  • Align key performance and operational incentives
  • Achieve back-office and support function synergies
  • Integrate IT platforms
  • Share intellectual capital by linking quality programs and best practices

Health systems that are looking to rapidly expand into neighboring markets may use MSAs as a growth vehicle through longer-term agreements with multiple smaller providers. Several large health systems and integrated delivery systems across the country have established management services as a separate and distinct business line for this purpose. Many of these MSAs have been around for decades, while in other cases systems are moving quickly to meet market demand for this form of affiliation.

Some organizations enter into MSAs as a way to “test the waters” for a defined period of time (e.g., five years) as a prelude to a full asset merger or other more integrated partnership. MSAs allow both entities a chance to work together and to assess operational and cultural compatibilities before pursuing a more binding arrangement.

Quantifying the Savings

The leaders of a community health system with an “A” rating and approximately $1 billion in net revenue sought a partnership that could provide the benefits of scale while allowing the organization to remain independent. The system was approached by a $4 billion multistate integrated delivery system with centralized shared services and a hospital in the same market as the community-based system.

The larger system presented the community system with a tailored “value proposition,” including the provision of shared services in the areas of supply chain, biomedical engineering, insurance, and risk. The savings for the community-based system were estimated at more than $35 million over five years. The community health system entered into the MSA and started building a relationship with the more advanced integrated delivery system. The agreement has the potential to expand to other areas, such as clinical affiliations and population health management initiatives.

Balancing Benefits and Risks

Before pursuing an MSA, organizations should consider both the benefits and potential challenges. MSAs often require complex negotiations to establish the management system and contract structure, including defining the duration of the agreement, performance targets and metrics, service commitments, and exit provisions. It is essential to ensure that incentives are aligned relative to the goals of each party, and that a shared vision for the partnership exists.

Smaller organizations may be concerned about being a low priority for the larger organization. Larger organizations, meanwhile, may be concerned about extending too much expertise, and thereby discouraging the managed entity from future interest in a more integrated partnership.

Overall, healthcare leaders should be aware that MSAs do not provide a quick fix. It often takes more than a year to realize the benefits of these agreements, and organizations should be prepared to commit the necessary time and resources to ensure a successful and productive partnership.

Ryan S. Gish is a managing director, Kaufman, Hall & Associates, LLC, Skokie, Ill., and a member of the firm’s Strategy practice.

David M. Cyganowski is a managing director,  Kaufman, Hall & Associates, LLC, and is based in New York City.

Discussion Starters

Forum members: What do you think? Please share your thoughts in the comments section below.

  • In which operational areas or service lines are management services agreement especially beneficial?
  • What are some reasons to be cautious about entering into a management services agreement?
  • What advice would you give a hospital or health system that is considering entering into a management services agreement?

Publication Date: Monday, August 17, 2015