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The Keckley Report

The Future for Hospitals: It’s Clear

By October 10, 2016March 1st, 2023No Comments

I participate in hospital strategic planning retreats frequently. Routinely, the question is asked: what’s our future? Though the pace of change is quickening and markets vary, the destination seems clear.


The origin of hospitals dates back 2500 years to facilities built by the ancient Greeks to serve their God of health, Asclepius, and to the third century B.C. Roman Basilias that housed healers who practiced their trade. From these beginnings, facilities devoted to identifying and treating diseases by healers migrated to Europe and then to North America where our first hospital, Pennsylvania Hospital, opened its doors in 1751.

From these roots, the role of a hospital as a gathering place for health professionals is unchanged. But how health is defined, how disease is diagnosed and treated, and how healing professionals engage with patients and their peers has changed dramatically.  In the twentieth century, First and Second Gen hospitals evolved with much in common but Third Gen hospitals in the U.S. are unlikely to resemble their predecessors.

First Gen U.S. Hospitals (circa 1947-2000): Thanks to legislation (Hill Burton Act, 1947) that funded hospital construction in every community and the introduction of Medicare and Medicaid programs (1965), 7200 hospitals were built. These First Gen Hospitals were anchors of their communities. They afforded employment to many, served as magnets for physicians, and anchored economic development. The science of healing was advancing as techniques for surgery improved and antibiotics and medicines found their way into medical practice. Hospital administrators focused on physician recruiting, community relations, and appropriating capital for a widening array of inpatient services. As RBRVS payments evolved and as investor-owned hospitals became prominent, competition for admissions became the prime determinant of success.

First Gen hospitals operated in a Field of Dreams: when we built them, they came. Specialization took front seat to preventive and primary care. Four beds per thousand was the norm. But the costs associated became problematic to employers and insurers who launched HMOs and capitated models to constrain runaway spending. By 2000, the shortcomings of capitation had run their course. Competitive pressures shrank the First Gen hospitals ranks to 6200 including 1200 owned by private investors by the beginning of the new Millennium.

Second Gen Hospitals (circa 2000-2015): By 2000, the economics of running a hospital had changed. Cost-plus reimbursement had given way to prospective payments. Early momentum by insurers to push capitation had stalled and health maintenance organizations had been stunted. Meanwhile, clinical innovation was accelerating: small molecule medicines were giving way to large molecule personalized therapeutics and companion diagnostics as the biotech industry came into its own. Cancer became a chronic condition as treatment methods matured. In tandem, costs soared prompting pushback by payers led by Medicare which used its muscle to push for prescription drug discounts for seniors (Medicare Modernization Act (2006), mandated used of electronic health records across the system (American Recovery and Reconstruction Act (2009) and replacement of private fee-for- service reimbursement with value-based incentives for hospitals and physicians (Patient Protection and Affordable Care Act (2010).  Hospitals and physicians became co-dependent: both faced reimbursement cuts, heightened risk for regulatory non-compliance and forced participation in payment programs requiring them to assume financial risk for results.

In response, affiliations and consolidation accelerated as multi-hospital system operators played larger roles. Outsourcing and group purchasing arrangements matured and the aggregation of physicians into clinically integrated networks became imperatives. 5627 hospitals, including 4926 community hospitals, made the transition from First Gen to Second Gen. Many changed their names to health system and all tiptoed into risk-sharing relationships with insurers and employers. Outpatient services replaced inpatient programs as the source of capital, operating margins thinned and bad debt increased, especially in states that did not expand their Medicaid programs. As the Second Gen era ends, bed oversupply, at 2.6 per thousand, is still an issue in some markets, but the larger issue is the transition from delivery of services to management of health. It’s a transition few are prepared to pursue.

Third Gen Hospitals: The opportunities and challenges are the result of five trends:

Changing Demand requiring Wider Scope: 10,000 elderly age into Medicare daily. Shortages in primary care services are driving alternative venues like retail clinics and televisits. Millennials and employers are demanding programs for well-being along with specialized services for those who are sick. They want a coordinated blend of alternative and traditional medicine, physical and mental health, technologies that equip them to participate actively in their care instant information about the costs they’ll shoulder in every transaction with their hospitals and caregivers and a full complement of retail and alternative health programs. Third Gen hospitals embrace an expanding definition of health that goes well beyond sick care services for patients in inpatient and outpatient settings to programs and services to maintain healthiness and wellbeing across the span of life including meaningful end of life care that’s affordable and sensible.

Clinical Innovation encompassing Total Health: Precision medicine and personalized health is the aim in Third Gen hospitals. Multi-disciplinary, team-based models that leverage clinical information technologies and advanced diagnostics are the operational backbone in these sprawling entities that compete with peers on the basis of total costs of care, user experiences, and outcomes. Physical medicine sits alongside mental health as integrated models, and alternative methods that embrace individual preferences and values are integrated in clinical practice guidelines. Third Gen hospitals are systems of health in which individuals are the centerpiece: their needs and values are central to how delivery is designed and delivered.

New Capital entering the System: Third Gen hospitals need capital to expand in retail, community and digital services for homes, schools and workplaces while maintaining acute, post-acute and primary care services in integrated programs. But credit-worthiness is increasingly tough: lenders and investors are wary about their risks and cautious about bets in organizations whose scale and scope are suboptimal. Third Gen hospitals will augment traditional capital sources through joint ventures—technology companies that bring e-Health and digital connectivity to reality, insurers that assist in financing care and population health and retail health giants who bring expertise in consumer behavior and a broader array of health-related discretionary purchasing opportunities.

Physician Networks become Medical Groups: One in three practitioners is currently employed by a hospital, most not by choice but as a matter of long-term security. The reality of physician burnout and threats of reduced reimbursement, cumbersome implementation of electronic medical records and forced participation in alternative payment programs via MACRA mean physicians aren’t happy. Nonetheless, well-organized groups of physicians have measurable advantages over disaggregated physicians who operate independently.  Third Gen hospitals will invest in well-managed clinically integrated networks of forward-looking clinicians are those who wield considerable advantage in the decade ahead.  The effectiveness of the physician enterprise operating as an efficient, market-savvy medical group will be key to a Third Gen system’s success.

Provider Sponsored Financing:  Third Gen hospitals will be in the business of financing healthcare. Delivery alone is not enough. Consumers and employers trust providers more than insurers but have issues with both: at the end of the day, creating affordable solutions in healthcare is imperative to the Third Gen hospital’s future. Mandated bundled payments by Medicare will become the mainstay for third party compensation. Many Third Gen hospitals will sponsor their own health insurance plans including some that will partner with private insurers. The bottom line: Third Gen hospitals will be in the health insurance business: they’ll own both the financing and delivery of care in their communities and regions.

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For some Second Gen hospitals, the Third Gen is a big leap. It’s not without risk, so boards and management must answer these questions objectively: 

  • Can we survive as a Second Gen organization? What are the risks and advantages? How does our cost, quality, and reputation performance compare to systems outside the community? Are we better served as part of a Third Gen system operated by someone else or should we hunker down and go it alone?
  • Are we able to transition our clinical operations to focus on individual consumers and their health, or are we more comfortable focusing on our users as traditional patients? 
  • How fast will conditions in our region shift demand and opportunities from Second Gen to Third Gen?
  • How will competing systems of health evolve, and who are they? How should we choose with whom to align?
  • Is owning and operating a health plan advantageous? Do market conditions warrant sponsorship of a plan or is partnering a better option? And what is our expertise and opportunity in retail and digital health?
  • How should opportunities in outsourcing, affiliations and third party capital be approached?
  • And given these challenges and opportunities, are we prepared to make appropriate decisions objectively? Do we have the right leadership and structure to make the transition to Third Gen? 

The Destination

The ancients in Greece and Rome created a cornerstone in our society: hospitals that serve as hubs of activity for healers. That will not change, but how and where it’s done will.

Third Gen hospitals will be systems of health that serve regions. They define health. They treat the sick and the well. They view their users as individuals, not patients. They deploy capital and provide services in homes and workplaces. They provide both health and human services. They bear responsibility for the financing and delivery of care. They’re paid for managing populations on a capitated basis. They’re diversified and comprehensive. They’re the future.



P.S. The evolution of hospitals in the U.S. toward fully integrated systems of health is a work in progress. For a discussion of systems of health, go to and review the June 6, 2016 posting “Third Gen Hospitals: Systems of Health”.

Paul H. Keckley, Ph.D., is Managing Editor, The Keckley Report and provides independent healthcare research and policy analysis.