June 24, 2024

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Lifeline or power grab? Palomar Health may cede oversight of CEO, other top executives to private company

7 min read

Under heavy financial pressure, elected leaders at Palomar Health are considering a significant management change that would end their direct supervision of the top executives who oversee the organization’s strategic planning and day-to-day operations.

Palomar’s seven-member board of directors met with attorneys last week to review an 18-page tentative contract with Mesa Rock Healthcare Management Inc., wading through the document during a special public meeting and promising to reconvene for more open discussion on Thursday.

For the record:

6:18 p.m. Feb. 26, 2024A previous version of this story incorrectly equated net income with net revenue in discussion of a proposed 1 percent management fee. We apologize.

The discussions are made more urgent by Palomar’s deteriorating financial situation. On Friday, Moody’s Investors Service notified revenue bond holders that it placed Palomar’s debt “under review for downgrade,” citing “a material and unexpected decline in unrestricted cash reserves … that has resulted in roughly 39 days cash on hand.”

In early 2022, Moody’s said in a statement that Palomar’s minimum cash covenants were 80 days and that anything “below 55 days constitutes an event of default.” But no such default has yet been publicly declared though Moody’s said in mid-2023 that cash on hand had then reached a historical low of 42 days, causing the firm to lower its outlook for Palomar’s future financial performance from stable to negative.

Palomar is not alone in its financial turmoil. Increased labor and supply costs following the COVID-19 pandemic have so strained health care organizations that the California Hospital Association warned in 2023 that “one in five hospitals are at risk of closure.”

The potential 15-year pact between Palomar and Mesa Rock has been pitched as a way for Palomar to resolve its financial troubles. Rather than start a search for new leadership before bond holders force them to do so, directors argue that the current management team needs more elbow room to turn things around.

Having the top layer of management employed by a private company rather than a public entity, proponents argue, would allow them to broker deals that executives say have often been derailed by concerns around the medical provider’s underpinnings in local government.

But taking this route would change the nature of the elected board members over executives and reduce the public’s access to information under state public records law.

Board Vice Chair Jeff Griffith said shifting Palomar’s leadership structure is critical to its survival.

“We are at a point where, if we don’t evolve past the regulatory problems that Palomar healthcare faces, we will not be successful,” Griffith said.

But John Clark, who has been vocal about his discomfort with management decisions in the past, and particularly with the organization’s bleeding balance sheet, called the proposal a power grab.

“I’m convinced that this is just a way for the CEO to transfer power from the board,” Clark said.

He asked his colleagues to support hiring an independent attorney to provide a “second opinion” on the proposed agreement, but that motion failed with only Clark and fellow board member Laurie Edwards-Tate in support.

The Mesa Rock proposal would, its creators explained to the board, essentially split off Palomar’s C-Suite into a private, not-for-profit, mutual-benefit corporation. But the elected board would continue to hold the purse strings, retaining its annual budget approval authority.

As it was presented in a public meeting Wednesday, the idea — thought to be unique for health care districts — is to leave all of Palomar’s assets, including its hospitals in Escondido and Poway and its affiliated medical group, in the hands of the elected board. Other than top managers, all employees would still work for the district.

If the deal is approved, Mesa Rock would employ Palomar CEO Diane Hansen and her direct reports, including chief financial, operating, medical and legal officers, Palomar’s chief nursing executive, and other personnel that the management company decides are necessary.

Changes in leadership structure are not unheard of for public health care districts such as Palomar. In the 1990s, the Grossmont Healthcare District leased its entire La Mesa hospital complex to Sharp HealthCare, which has run the enterprise for decades under a private board. Tri-City Medical Center in Oceanside, facing its own budget problems, is working on a joint agreement with UC San Diego Health that would transfer district assets to a new entity with governance tilted toward, but not dominated by the university.

The management company would receive 1 percent of Palomar’s net revenue for its operations, but portions of that cash not spent during a given fiscal year would be spent on health care services. This amount, a Palomar representative confirmed Monday, would be paid whether or not the district’s operations generated a profit.

At the moment, Palomar is running in the red. Palomar’s most recent quarterly financial disclosure, which shows operations through Dec. 31, 2023, lists a $27 million net loss against a budget that predicted a $16 million net income.

There has been significant grumbling among some in the community about Palomar’s numbers, especially because they have affected the bond ratings of more than $700 million in outstanding debt.

If the proposed management services agreement with Mesa Rock was approved, the elected hospital board would find it more difficult to take direct action against its CEO.

Palomar directors, lawyers confirmed, would no longer possess the ability to fire the CEO. That authority would rest with Mesa Rock’s appointed board of directors. However, if Palomar directors were unhappy with Hansen’s or any future CEO’s performance, and the Mesa Rock board did not resolve the matter to the Palomar board’s satisfaction, it could terminate the contract, paying out severance to executives and other costs incurred while winding down the management company’s operations.

Though it would give up its ability to directly fire its CEO, Palomar directors would retain the right to veto a new chief executive hire proposed by Mesa Rock. Palomar would pay executives’ salaries, but would have final budget approval on any proposed raises.

As a state-chartered special district with directors chosen by voters, Palomar is subject to the California Public Records Act, making some records — even internal emails — available to the public through written requests. But that would not be the case for executives employed by Mesa Rock. As a private company, attorneys confirmed, its records would not be considered public.

Creating an environment where Palomar’s top executives are free to broker deals without discussions being subject to public records concerns, said John Kern, an attorney hired by Palomar to create the management agreement, is seen as key to helping the organization compete on an even playing field with private players.

Of course, there are several examples of Palomar collaborating with private medical providers. Until recently, for example, its hospitals have allowed Kaiser physicians to see Kaiser patients within their halls under a contract that lasted for decades. And, Palomar continues to contract with Rady Children’s Hospital to run its neonatal and pediatric units.

But Kern said that other proposed deals, which he said he could not name, have fallen apart out of reluctance of private organizations to work with a public entity.

“They imagine, I think, increased regulatory scrutiny,” Kern said. “They imagine constant pressure and criticism from a publicly elected board that they consider not sophisticated enough to understand and potentially causing them embarrassment and reputational harm and business harm.”

Hansen, Palomar’s CEO, said after Wednesday’s special meeting that she believes that some of the potentially lucrative deals that have stalled could move forward if the Mesa Rock deal happens.

“I would expect that, when this gets approved, you can anticipate there will be some announcements coming out of Palomar Health,” Hansen said.

Mesa Rock’s plans for governance are something of an enigma.

Though they spoke of the company Wednesday as if it exists, that was barely the case as the meeting unfolded.

William Kushner, a San Francisco attorney who said he was hired to create Mesa Rock, told the board that the paperwork to incorporate the organization was filed with the California Secretary of State on Tuesday and, to date, its “bylaws haven’t been adopted yet.”

Kushner further shared that his actions have been at the behest of Eric Friedlander, a resident of Sonoma County. Though the attorney indicated that the board had “seen his bio,” he provided no summary of Friedlander’s qualifications except to say he has no personal involvement with Palomar. Kushner did not indicate why a resident of Northern California was suddenly becoming so intimately involved with a major change in leadership structure at a Southern California public health care district.

Friedlander declined, through his attorney, to explain his involvement.

Hansen said Friedlander has deep experience running ambulatory surgery centers. Though Kushner did not confirm the fact, the executive appears to be connected to Starpoint Health, a company that runs ambulatory surgery centers in Los Angeles.

“Eric is an expert in health care,” Hansen said, adding that his background includes surgery centers. “That’s why it was important for us to find someone who had that background.”

The most important immediate open question is: Who will be appointed to the board of directors that runs Mesa Rock, which will ultimately have the power to fire Palomar’s CEO and also to directly oversee the work of the two-hospital health system’s operations and market strategy?

Kushner said that this information would not be available until after a deal is done, telling the board “we’re going to have a separate sole director until this agreement is in place, then the most-important conversation will be, ‘well, what is the governance structure for this not-for-profit?’ ”

Asked by email to elaborate on the selection process for Mesa Rock’s board of directors, Kushner declined to say more.


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