Response by Alameda Health System to 2014-2015 Civil Grand Jury Report*

Conclusions 8

• CL1
  The Alameda Health System Board of Trustees failed to ensure that a prudent and professional due diligence process was conducted from the period of May to October 31, 2013, allowing the financially damaging acquisition of San Leandro Hospital to be completed. AHS Response to Finding 15-9: AHS disagrees with this finding. This Finding appears to suggest that the Board of Trustees was unaware of the risks associated with the acquisition of San Leandro Hospital ("SLH") and failed to insure that AHS management had properly identified and explained the potential risks. This conclusion is premised on the fact that ultimately SLH was not profitable at the time of acquisition and continued to operate in a manner that required resources from AHS beyond the revenue that it generated. In our view, this approach confuses two separate and distinct issues - what the Board knew and what the Board decided - in a fashion that unfairly characterizes the quality of the decisions made by the Board. "Prudent and professional due diligence" does not concern a question of whether the SLH acquisition proved unsuccessful, but, rather, whether in evaluating the acquisition, the Board of Trustees had, or requested from management, sufficient and appropriate information to determine the risks of the proposed transaction in light of the organizations current - circumstances, to evaluate the risks of the transaction, and to make an informed decision to proceed with the transaction. There is ample evidence that the Board satisfied this standard and completed its due diligence, notwithstanding the ultimate outcome - which AHS would point out is yet indeterminate. The Board considered three options regarding the acquisition of San Leandro Hospital: 1. Continue to operate the hospital in its current configuration while pursuing service line additions, surgical volume increases, and stronger payer relationships. Convert the hospital to a rehabilitation facility immediately, cease acute care operations, and continue performing outpatient procedures. 3. Convert two floors of the hospital to a rehabilitation facility, maintain the acute care operation, and pursue service line and volume opportunities. Before undertaking the acquisition, the record demonstrates that AHS identified each of the potential risks associated with the proposed alternatives, including the historical deficits incurred in the operation of SLH as an acute care facility and the need for and potential impact of subsidies from Sutter, the City of San Leandro, and the County (in the first year) and Eden, the City and the County (in the second year) to mitigate the adverse impact of those deficits during that period. The Board also considered as a risk the need to establish (and the cost thereof), and the potential impact of, a rehabilitation care service at the location (in the third year of operation) to generate a distinctive, sustainable revenue stream upon termination of the outside subsidies. All of these considerations are reflected in the Board discussions of July 20 and August 27, 2013, the report of the outside consultant (provided to the Board in advance of those meetings), and the advice of the General Counsel and CFO in due diligence memoranda provided to the Board for review. The Report appears to suggest that the Board's decision to enter into an assessment of the proposed transaction by signing the letter of intent in May 2013 is, in and of itself, a violation of its fiduciary duty to effect a prudent due diligence. However, at that juncture and now, AHS was required to pursue opportunities to resolve the need for relocation of its rehabilitation services from the Fairmont campus. Exploring the opportunities offered by the SLH acquisition - under a letter of intent that presented no binding obligations - was an appropriate course to consider given the statutory imperative to find a new location for AHS rehabilitation services. The potential risks of the transaction were balanced against the opportunity for a solution to the County's need to relocate rehabilitation services from the Fairmont campus and community interest in avoiding an immediate closure of SLH as an acute care facility. After entering into the letter of intent, management undertook appropriate steps to weigh the risks: engaged an outside consultant to evaluate the potential success of differential financial configurations for the facility post acquisition; engaged outside counsel, with substantial experience in hospital acquisition transactions, to assist in developing an appropriate acquisition plan; and presented the findings of the outside consultant and outside counsel, augmented by staff evaluations from the General Counsel and CFO, to the Board before a definitive agreement committing AHS to the transaction was concluded. In the course of this process, the Board articulated specific concerns regarding the potential acquisition project and directed management to conduct additional analysis and evaluation to address those concerns. The record - discussions at the Board meetings in July and August - establishes a probing inquiry by the Board and robust discussion of the pros and cons of the transaction based upon the prior analysis conducted by management and management's response to the concerns raised by the Board. The record also establishes that the Board undertook these discussions in the context of the potential financial issues that had evolved in mid-2013 as the result of the cash flow problems encountered with the launch of the Soarian system. "Due diligence" concerns the principle of a responsible governing board undertaking appropriate inquiry and evaluation to determine that a potential transaction is what it seems and that it will potentially result in anticipated outcomes. In this instance, circumstances that ultimately affected the outcome of the SLH acquisition - the failure to realize anticipated subsidies, the impact of the industry changes resulting from how the Affordable Care Act played out in Alameda County and California as a whole - were neither ignored nor unreasonably anticipated. On the contrary, the record demonstrates that the ultimate outcome - the realization of all of the subsidies and the impact of ACA - simply did not comport with the Board's initial positive evaluation of the development of these circumstances. There is no evidence to suggest that the Board's expectations were unrealistic to the point of recklessness or irresponsibility. In the first year, Sutter, the City, and the County came through with the promised subsidies. In the second year, the City and the County made good on their promises. The fact that the subsidies anticipated from Eden did not materialize because of a change in position by Eden, while unfortunate and unanticipated, was not an unreasonable risk against the need to obtain the benefit of the transaction at the time it was pursued. While hindsight analysis of the transaction may confirm that a different approach would have yielded a different result, it is not appropriate to conclude that such hindsight judgment establishes a failure by the Board based on the information that it had and considered at the time these decisions were made. That said, the AHS Board has gained valuable insight and experience from its post-mortem consideration of its action in this matter. That analysis has resulted in more rigorous analysis of the current and future assessment of its financial metrics and analysis (see discussion of the Civil Grand Jury Recommendations below). Moreover, despite the initial difficulties encountered with the transaction, the circumstances have shifted to a positive outlook for the ultimate success of the transaction: 1. The facility has continued to operate as a valuable community asset providing a much-needed community resource for acute care and emergency services. 2. The SLH facility has improved its performance, capitalized on market opportunities and is on a trajectory to contribute in a positive fashion to the overall mission of AHS 3. A viable plan is in place to realize the value AHS services will bring once relocated to SLH. (A recent briefing on the status of SLH is attached as Attachment A.) 1 The Soarian Financials system is patient accounting software package that had been scheduled for deployment in 2013. AHS experienced significant difficulties implementing the new system and as a result, financial operations were negatively impacted, particularly in the areas of patient billing and charge capture.
• CL2
  By the end of November 2013, the Alameda Health System Board of Trustees was fully aware of the major financial issues Alameda Health System faced and the fact that Alameda Health System would not meet its year-end financial obligation to the county, but failed to provide the contractually obligated written notice to the county. AHS Response to Finding 15-10: AHS agrees with this finding in part and disagrees with this finding in part. It appears that AHS did not provide a specific written notice to the Alameda County Auditor- Controller that it was in jeopardy of meeting the terms of its year-end financial obligation. However, the record is equally clear that AHS was transparent in the financial performance issues that would affect its ability to meet its obligation to the County and that it collaborated with the County staff, including the County Administrator and Auditor-Controller, to mitigate the consequences of its inability to meet the terms of the debt reduction. Ultimately, AHS worked with the Auditor-Controller to revise the terms of its debt obligation and to establish a new framework for debt reduction in light of the financial pressures that it was experiencing. Under the new reporting procedures that have been adopted by AHS and the County to guide collaboration on financial issues, it is unlikely that this situation will recur. As explained below, AHS will share and report on its financial condition to the Health Committee and HCSA on a regular basis, providing each agency ongoing insight into potential issue that require action before they reach a critical point.
• CL3
  There was a need for at least $50 million in cost reductions to provide the Alameda Health System with a sufficient operating margin to repay the county loan and pension obligations, while attempting to achieve its strategic vision. This was first identified in November 2013, but little action was taken for at least one year in response to this need. AHS Response to Finding 15-12: AHS disagrees with this finding. The Report suggests that AHS delayed until November 2014 before taking steps to address financial issues.2 This conclusion ignores a key underlying issue for the cash flow problems that 2 As the Report notes, the problematic implementation of the Soarian system resulted in revenue shortfall of as much as $50MM+ at the beginning of FY 2013-2014. This unanticipated event was correctable and the organization reasonably determined that the problems with the system could be fixed and the lost revenue occurred early in the fiscal year - the Soarian implementation and overlooks several facts that are key to understanding and appreciating proactive interventions undertaken by the organization to control costs and to improve efficiencies before Soarian became an issue. As early as 2012, AHS had undertaken a series of Financial Performance Initiatives ("FPI") to address process and structural improvement opportunities across the organization. FPI #14 was the Building Excellence Through Timely Expense Reduction (BETTER I) initiative that was launched by the organization in September 2012 to address cost management, operational improvements, and personnel realignment. BETTER I was designed to identify and to capture a fiscal improvement of just under $20M. BETTER I was targeted to meet its goal by December 2013. BETTER II, a continuation of savings and reductions started under BETTER I and a comprehensive assessment of the revenue cycle, was already in the planning stages before BETTER I was completed. As early as October 2013, AHS had initiated a further round of cost- saving activity under BETTER II that targeted and additional $20MM in savings and revenue improvements. BETTER II is nearing a successful conclusion. AHS has adopted across-the-organization cost reductions that have been fully implemented and will result in a projected EBIDA margin of 5% for FY 2015-2016. At the Governance level, the AHS Board of Trustees communicated its concerns as early as February 2014 for added expertise in financial matters as the Board of Supervisors considered new Trustee appointments. The need for this expertise and support was reiterated to the Board of Supervisors in June of 2014.3 Recommendations for appointment to the Board of Trustees will continue to focus on background and experience and health care management.
• CL4
  The resulting delay in implementing the cost savings program of at least $50 million means that Alameda Health System will need to add additional savings projects of similar magnitude in subsequent years to remain financially viable. AHS Response to Finding 15-13: AHS disagrees with this finding. As explained in the foregoing section, AHS had undertaken timely steps to align its costs with its revenue capabilities and has continued that approach since 2012. More importantly, in the course of implementing BETTER II, and with the full implementation of the Affordable Care recaptured. The problems with Soarian would not have been cause for sweeping permanent changes, given the anticipated temporary impact of the problems experienced. 3 Copies of correspondence to the Board of Supervisors are attached as Attachment B. Act, AHS leadership shifted focus to refining and strengthening its revenue cycle performance and, as a result, has steadily improved the organization's capability and capacity to capture revenue from the services that it provides.
• CL5
  Had open, transparent communications and proper oversight by both the Alameda Health System Board of Trustees and the Alameda County Board of Supervisors been in place from July 2013, the cash flow issues would have been controlled earlier and cost restructuring targets achieved sooner, mitigating the impact of the current delay. AHS Response to Finding 15-14: AHS disagrees with this finding. The finances of AHS and the provision of safety net services at the core of its mission are not susceptible of the analysis reflected in this finding. Add to that, the inherent unpredictability and variability of the prior reimbursement-based revenue structure and the need to incorporate fee- for-services structures as the result of the implementation of the Affordable Care Act, determining the trajectory of AHS's financial issues is not as one-dimensional as portrayed in the Report. The AHS Board of Trustees has communicated regularly with the Board of Supervisors regarding its operations and financial situation, having appeared regularly before the Board of Supervisors Health Committee. These communications have addressed the cash flow issues faced by the organization and the assistance from the County needed to mitigate the issue. The County and AHS are working on a revised operating agreement that incorporates a specific communication plan, on a going forward basis, for sharing financial information between the organizations. AHS Responses to Recommendations
• CL6
  Continue to operate the hospital in its current configuration while pursuing service line additions, surgical volume increases, and stronger payer relationships. Convert the hospital to a rehabilitation facility immediately, cease acute care operations, and continue performing outpatient procedures.
• CL7
  The SLH facility has improved its performance, capitalized on market opportunities and is on a trajectory to contribute in a positive fashion to the overall mission of AHS
• CL8
  Convert two floors of the hospital to a rehabilitation facility, maintain the acute care operation, and pursue service line and volume opportunities. Before undertaking the acquisition, the record demonstrates that AHS identified each of the potential risks associated with the proposed alternatives, including the historical deficits incurred in the operation of SLH as an acute care facility and the need for and potential impact of subsidies from Sutter, the City of San Leandro, and the County (in the first year) and Eden, the City and the County (in the second year) to mitigate the adverse impact of those deficits during that period. The Board also considered as a risk the need to establish (and the cost thereof), and the potential impact of, a rehabilitation care service at the location (in the third year of operation) to generate a distinctive, sustainable revenue stream upon termination of the outside subsidies. All of these considerations are reflected in the Board discussions of July 20 and August 27, 2013, the report of the outside consultant (provided to the Board in advance of those meetings), and the advice of the General Counsel and CFO in due diligence memoranda provided to the Board for review. The Report appears to suggest that the Board's decision to enter into an assessment of the proposed transaction by signing the letter of intent in May 2013 is, in and of itself, a violation of its fiduciary duty to effect a prudent due diligence. However, at that juncture and now, AHS was required to pursue opportunities to resolve the need for relocation of its rehabilitation services from the Fairmont campus. Exploring the opportunities offered by the SLH acquisition - under a letter of intent that presented no binding obligations - was an appropriate course to consider given the statutory imperative to find a new location for AHS rehabilitation services. The potential risks of the transaction were balanced against the opportunity for a solution to the County's need to relocate rehabilitation services from the Fairmont campus and community interest in avoiding an immediate closure of SLH as an acute care facility. After entering into the letter of intent, management undertook appropriate steps to weigh the risks: engaged an outside consultant to evaluate the potential success of differential financial configurations for the facility post acquisition; engaged outside counsel, with substantial experience in hospital acquisition transactions, to assist in developing an appropriate acquisition plan; and presented the findings of the outside consultant and outside counsel, augmented by staff evaluations from the General Counsel and CFO, to the Board before a definitive agreement committing AHS to the transaction was concluded. In the course of this process, the Board articulated specific concerns regarding the potential acquisition project and directed management to conduct additional analysis and evaluation to address those concerns. The record - discussions at the Board meetings in July and August - establishes a probing inquiry by the Board and robust discussion of the pros and cons of the transaction based upon the prior analysis conducted by management and management's response to the concerns raised by the Board. The record also establishes that the Board undertook these discussions in the context of the potential financial issues that had evolved in mid-2013 as the result of the cash flow problems encountered with the launch of the Soarian system. "Due diligence" concerns the principle of a responsible governing board undertaking appropriate inquiry and evaluation to determine that a potential transaction is what it seems and that it will potentially result in anticipated outcomes. In this instance, circumstances that ultimately affected the outcome of the SLH acquisition - the failure to realize anticipated subsidies, the impact of the industry changes resulting from how the Affordable Care Act played out in Alameda County and California as a whole - were neither ignored nor unreasonably anticipated. On the contrary, the record demonstrates that the ultimate outcome - the realization of all of the subsidies and the impact of ACA - simply did not comport with the Board's initial positive evaluation of the development of these circumstances. There is no evidence to suggest that the Board's expectations were unrealistic to the point of recklessness or irresponsibility. In the first year, Sutter, the City, and the County came through with the promised subsidies. In the second year, the City and the County made good on their promises. The fact that the subsidies anticipated from Eden did not materialize because of a change in position by Eden, while unfortunate and unanticipated, was not an unreasonable risk against the need to obtain the benefit of the transaction at the time it was pursued. While hindsight analysis of the transaction may confirm that a different approach would have yielded a different result, it is not appropriate to conclude that such hindsight judgment establishes a failure by the Board based on the information that it had and considered at the time these decisions were made. That said, the AHS Board has gained valuable insight and experience from its post-mortem consideration of its action in this matter. That analysis has resulted in more rigorous analysis of the current and future assessment of its financial metrics and analysis (see discussion of the Civil Grand Jury Recommendations below). Moreover, despite the initial difficulties encountered with the transaction, the circumstances have shifted to a positive outlook for the ultimate success of the transaction:

No Responses Found 1

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