Layoffs. Losses. Lawsuits. ‘Rules are being rewritten’ for California health care giant

Sutter Health has been the pre-eminent hospital chain in Northern California for decades — respected but also feared.

Critics say it has strong-armed insurance companies and major employers into contract terms that inflated health care prices across the region. State officials blamed Sutter for making Sacramento the most expensive city in America for delivering a baby.

Now, this formidable organization — with two dozen hospitals, 12,000 doctors and 3 million member patients — is facing a reckoning over the way it does business.

In January, the Sacramento-based health care organization laid off 274 workers. It has eliminated another 800 jobs through voluntary buyouts, and in March it announced major financial losses and a “sweeping review” of its operations and costs. Sutter Chief Financial Officer Brian Dean says further staff reductions are likely.

Sutter says its troubles had been building for years — and were magnified when COVID-19 struck, escalating costs and prompting home-bound patients to cancel visits to the doctor.

Yet Sutter’s problems won’t go away once the pandemic runs its course.

Later this year, Sutter is expected to finalize a landmark court agreement settling an antitrust lawsuit brought by the state and a health care plan run by the United Food and Commercial Workers. In a deal first announced 18 months ago, Sutter agreed to pay $575 million in damages to a collection of self-insured employers, including corporations and government agencies.

More importantly, it agreed to abandon a series of contracting practices that, according to the lawsuit, had put insurance companies and self-insured employers at Sutter’s mercy. Sutter has been so dominant that state officials claimed these practices drove up prices all over Northern California, even for customers using other hospitals and doctors.

Sutter didn’t admit to any wrongdoing but the agreement is expected to tilt the balance of power between Sutter and the insurers, employers and patients who pay its bills. The settlement requires Sutter to be scrutinized by a court-approved monitor for a decade to make sure it complies with the terms.

“They have been basically writing all the rules for 20 years,” said Glenn Melnick, a health care economist at USC who’s been following the litigation. “They’ve been writing all the rules, and now the rules are being rewritten.”

Dean downplayed the potential impact of the court case.

“We are comfortable with what we agreed to in the settlement as a part of how we run our business, serving our mission, serving the community,” the Sutter CFO said. “I don’t know that there is a significant change in how we have been running the business.”

Yet the case has clearly put Sutter in an unflattering light. The Sacramento organization’s alleged misdeeds were paraded in front of a national TV audience when CBS’ “60 Minutes” aired a story on the case last December.

“They’re like the bully on the block,” then-California Attorney General Xavier Becerra, who led the litigation against Sutter, told the program.

“They were able to bully everyone else to conform; it was my way or the highway,” said Becerra, who is now secretary of Health and Human Services in the Biden administration.

Now the entire health care industry is waiting to see how the antitrust settlement affects Sutter’s behavior. “People will be looking at this,” said Bob Leibenluft, a health care antitrust specialist at the Hogan Lovells law firm in Washington, D.C. “It’s not just in your neck of the woods.”

Sutter’s legal woes won’t disappear when the settlement gets wrapped up. A separate class-action lawsuit, led by a group of Bay Area patients pursuing essentially the same allegations as the state’s case, is scheduled for trial in October in U.S. District Court in San Francisco.

Regardless of what happens in that case, Sutter’s world is clearly changing.

“They’ve always had the reputation of being able to extract from insurance companies really high reimbursement rates,” said Joanne Spetz, a health care finance professor at UC San Francisco. “They are going to have to strategically pivot ... to a world in which they’re not going to have the market power.”

A health care powerhouse based in Sacramento

It’s not as if Sutter is in danger of going broke.

The nonprofit sits on an empire of real estate, cash and other assets totaling $20.4 billion. While focused primarily on the Sacramento Valley and Bay Area, its hospitals, clinics, outpatient surgery centers and other facilities stretch from Crescent City on the North Coast to Carlsbad, near San Diego. It operates a behavioral health clinic in Hawaii, about 10 miles west of Pearl Harbor.

Even in a year ravaged by COVID-19, when patient counts plunged, it generated $13 billion in revenue in 2020. Its staff cuts amount to a fraction of the more than 53,000 workers it employs. Its employees are well paid; Chief Executive Sarah Krevans received $4.2 million in total compensation in 2019, the last year for which figures are available.

And the organization overall is still making money. Despite substantial operating losses last year, Sutter recorded an overall profit of $134 million, thanks to gains in its investment portfolio.

But Sutter executives say they can’t rely on investment income to sustain the organization. What counts are its day-to-day operations — “the core of the going concern of the company,” said Dean, the chief financial officer. After operating losses piled up last year, the three major Wall Street debt-rating agencies downgraded Sutter’s credit rating a notch, although the ratings are still strong.

“The rating action reflects our view of Sutter’s weakened performance in 2020,” S&P Global Ratings wrote, “largely as a result of COVID-19 but also a result of Sutter’s underlying operating structure that will likely take a couple of years to fully address with a sizeable and multiyear turnaround.” S&P lowered Sutter’s rating on Sutter’s bonds from A-plus to A.

Dean said Sutter’s “financial headwinds” have been building for several years before the pandemic, largely because of an increase in its Medicare and Medi-Cal patient rolls.

For instance, Medicare accounted for 45% of Sutter’s business last year, up from 42% three years earlier, according to a report by credit analyst Fitch Ratings. That’s put stress on Sutter’s operating margins, as reimbursements from the federal government don’t cover the organization’s costs. Sutter spokeswoman Amy Thoma Tan said Sutter hospitals lost an average of $1,848 a day on Medicare patients in 2019.

How COVID-19 hammered Sutter’s finances

When COVID-19 struck, Dean said Sutter’s festering problems were exacerbated. Because of stay-at-home orders, hospital usage dropped 23%, according to Sutter financial reports. Outpatient surgeries fell 73%. Operating costs rose $100 million as Sutter scrambled to buy ventilators, protective clothing and more.

The result was, by Sutter’s standards, a bloodbath: an operating loss in 2020 of $321 million, followed by an additional operating loss of $49 million in the first three months of this year.

Most of the bleeding occurred in the Bay Area. Sutter’s facilities in and around San Francisco lost $409 million last year, compared to a profit of $109 million in the Central Valley. A geographic breakdown of profits and losses wasn’t available for the first-quarter 2021 results.

Sutter’s financial performance would have been far worse if not for COVID-19 assistance from Congress. The first stimulus bill, the CARES Act, pumped about $800 million into Sutter’s coffers. Otherwise, its operating losses in 2020 would have exceeded $1 billion.

The financial pain from COVID has left the entire industry wheezing. Kaiser Permanente recently disclosed 200 layoffs in Northern California. A study commissioned by the California Hospital Association found that hospitals in the state lost a combined $14 billion last year, although CARES Act money cut the losses to $8 billion. The hospitals can expect to lose as much as $2 billion this year, the study said.

Sutter believes its road to salvation lies in a thorough re-examination of its operations. That includes the fundamental delivery of medicine: Among other things, Dean said Sutter expects many of its patients to continue chatting with their doctors by video, well after the pandemic subsides, rather than troop into the office.

Yet reducing costs won’t be easy. Sutter says labor accounts for 60% of its operating costs, and the organization operates in a high-wage neighborhood. A 2018 study for the state Board of Registered Nursing showed that the average nurse was paid $114,000 a year in Sacramento, $120,000 in San Francisco — and just $99,000 in Los Angeles.

The prognosis calls for more upward pressure on wages. About a quarter of Sutter’s workforce is unionized, and most of those employees have contracts expiring this year. Dean said he doesn’t believe Sutter is “on a collision course” with its unions, but he signaled that more reductions in the overall labor force are coming.

“As we look at labor costs in the aggregate, I think that looking at how we run the business more efficiently is going to be critical and sometimes that results in workforce reductions,” he said.

As it is, Fitch Ratings said Sutter has already reduced its labor costs by about $180 million a year. Of the nearly 1,100 workers laid off or bought out in the past year, all were in non-clinical positions, meaning they weren’t directly involved in patient care.

Dean said it will likely take three years to execute the financial turnaround Sutter is planning, but the overhaul won’t end there. Cost containment will become a permanent “part of the fabric of how we run the business,” he said.

California has tried for years to control Sutter

In 1999, when Sutter was still building its powerhouse, the state tried to intervene.

Then-Attorney General Bill Lockyer sued to block Sutter from taking over the struggling Summit Medical Center in Oakland and merge it with Sutter’s Alta Bates hospital in neighboring Berkeley.

By then Sutter’s growing muscle was becoming evident. The Sacramento organization had entered the Bay Area market a few years earlier by purchasing a cluster of hospitals, and Lockyer said the East Bay takeover could lead to higher prices.

The courts ruled against him, and Locker was unable to block the takeover. His prediction about pricing became reality. Although Sutter kept both hospitals open, a 2008 Federal Trade Commission analysis found that Sutter was able to raise rates by as much as 72% at Summit in the years following the takeover.

Big purchasers of health care — insurers and self-insured employers — tried to rein in Sutter over the years, with mixed results. In 2005, a labor-backed group called the California Health Care Coalition announced a public campaign against Sutter, singling out the organization for charging hospital fees at least 60% higher than its competitors.

This came a year after CalPERS, the state’s public employee pension fund, ran newspaper ads ripping Sutter for its costs.

“Every citizen in the state of California should be outraged by Sutter,” the pension fund’s president Sean Harrigan said at one point. Harrigan was a top official with the United Food and Commercial Workers — the same union that sued Sutter a decade later.

CalPERS was able to drop 13 wanted Sutter hospitals from its network, but that’s been a rarity. Melnick said many purchasers have had to make do with “all-or-nothing contracts” forcing them to cover Sutter hospitals they didn’t want.

In the Bay Area, if they wanted access to Sutter’s well-regarded California Pacific Medical Center facilities in San Francisco — “the jewel of San Francisco,” Melnick said — they’d have to agree to cover hospitals that might be nowhere near where their employees lived.

“Employers were required to include their entire network, regardless of price, regardless of quality, regardless of geographic need,” said Elizabeth Mitchell, chief executive of the Purchaser Group on Health, a San Francisco nonprofit that helps big employers like Intel and Chevron negotiate health care contracts. “It is almost impossible to tell where the money’s going.”

And if they did succeed in carving out some of Sutter’s hospitals, Melnick said the savings usually have been minimal. Sutter would charge huge fees anytime a patient visited a Sutter emergency room that was outside the network, he said.

“That’s a huge flow (of revenue),” he said.

What’s more, he said Sutter has imposed “anti-steering” language to keep insurers from using higher co-payments as incentives to steer patients away from costlier providers.

Melnick said most insurers and employers concluded it wasn’t worth the effort to try to resist Sutter’s tactics.

“If I’m Blue Cross, do I really want to start a fight with Sutter? If I lose, they have market power, they could really sock it to me later. Then I’m worse off than my competitors.”

Sutter’s power didn’t just affect its own customers. Melnick said they created an “umbrella effect” that enabled its competitors to raise their prices, too.

“I think that they have been quite powerful at essentially setting the prices for the entire market,” Mitchell said.

Will court case make health care more competitive?

The union representing thousands of California supermarket workers agreed.

In 2014, the $500 million-a-year health care plan run by the United Food and Commercial Workers sued Sutter in San Francisco Superior Court.

“A substantial portion of the high cost of health care in Northern California is directly attributable to the illegal, anti-competitive behavior of Sutter,” the lawsuit said.

Four years later, the state joined the UFCW’s lawsuit. State officials cited studies showing the high cost of health care in the region — a condition they blamed squarely on Sutter.

The attorney general cited a consultant’s study that said delivering a baby in Sacramento cost an average of $15,000 in 2016, more than any other major metro area in the country. The study said Sacramento was also the most expensive city for cesarean delivery, at an average of $27,000. The state also referenced a UC Berkeley study showing a range of medical procedures that were twice as expensive in Northern California as in the south state.

The Berkeley study also revealed how high prices were trickling down to rank-and-file patients: Unsubsidized Northern Californians paid 35% higher premiums than south state residents for coverage through Covered California, the state’s online market for the Affordable Care Act.

In court papers filed earlier this year, lawyers for the state and the United Food and Commercial Workers Union’s health care plan said they would have sought damages totaling $980 million — their estimate of how much Sutter had inflated prices over the course of about 15 years — if the case had gone to trial.

Sutter fought back against allegations that it had done anything wrong. In a court filing in spring 2019, it said its hospital fees were based on “each hospital’s local competitive circumstances, demand for its services, patient demographics, capital needs and labor costs.”

Shortly after a jury was selected in late 2019, the case was settled.

The preliminary agreement called for Sutter to pay $575 million in damages and abandon long-standing anti-competitive practices, including the “all-or-nothing” and “anti-steering” clauses that critics say have been driving up costs. A cap will be placed on those out-of-network emergency-room fees.

Experts said the new generation of health care contracts will be more favorable to purchasers. The change in business practices should limit Sutter’s ability to impose “egregious pricing,” Mitchell said. “We will see a much more affordable and competitive market.”

The effects should be felt throughout the region. Now that Sutter is being forced to abandon its anti-competitive practices, that should reverse “the umbrella effect” that’s enabled all health care providers to over-charge their customers, Melnick said.

“Sutter is such a big player,” he said. “If they start to constrain their prices, the guys across the street will have to lower their prices. You’ll start to see price competition again.”