Palomar Health’s Financial Crisis: Is Private Management the Answer?

Most MHA and healthcare MBA students who interview for internships and jobs with county medical centers and other state and local hospitals expect that they would work for such institutions as public employees following an offer.

But if such facilities follow the controversial lead of California’s largest public healthcare district, public/private distinctions like those might soon become a lot more complicated.

A public healthcare district known as Palomar Health operates the Palomar Medical Centers in Poway and nearby Escondido near San Diego. Covering 800 square miles, Palomar Health is the largest public healthcare district in California by area and one of the largest in the United States.

Like many hospital systems across the nation in 2024, Palomar faces a rapidly deteriorating financial situation because of skyrocketing costs for labor and supplies brought about by the Covid pandemic. These financial challenges are particularly acute in California, and MHAOnline readers unfamiliar with the financial situation affecting many hospitals within the state might be surprised to learn about the severity of this crisis.

For example, a financial analysis commissioned by the California Hospital Association warned in 2023 that 20 percent of the state’s hospitals are at risk of closing: “Growing operating losses, combined with declining cash balances and debt loads, place many hospitals in unsustainable financial positions,” said the report prepared by Kaufman Hall and Associates.

Kaufman Hall’s analysis additionally found that relative to pre-pandemic levels, statewide operating margins remained significantly depressed, and expenses were substantially elevated. Total expenses in 2022 were $23.4 billion more than in 2019. Moreover, losses in 2022 amounted to about $8.5 billion—on top of $12.1 billion in losses during the previous two years.

On February 23, Moody’s Investors Service alerted bondholders that it had launched a downgrade review of Palomar Health’s debt because of an unexpected crisis triggered by a sharp drop in cash reserves to only about 39 days of cash on hand. Palomar’s bondholder terms specify that 55 days or less “constitutes an event of default.” However, even though Moody’s downgraded its outlook for Palomar’s financial performance from “stable” to “negative,” no such default event has yet been formally declared.

Only six days later, on February 29, Palomar’s publicly elected, seven-member board of directors voted to approve a 15-year contract with Mesa Rock Healthcare Management Inc.

Mesa Rock is a private, nonprofit management corporation organized and incorporated only one week before the vote. In fact, its bylaws were still not approved at the time of the vote, and no governance structure for the new entity—such as a board of directors—had yet been announced.

Oddly enough, few public details were known about the executives in charge of Mesa Rock during the board’s deliberations, and it remains unclear who exactly runs the brand-new corporation. The San Diego Union-Tribune had reported that San Francisco lawyer William Kushner represents Mesa Rock. Kushner told the newspaper he set up the new company while working for a resident of Sonoma County in Northern California named Eric Friedlander. The Union-Tribune then reported that Friedlander was associated with Starpoint Health, a 35-year-old Newport Beach-based firm that operates multi-specialty ambulatory surgery centers in Los Angeles.

The Mesa Rock agreement ends the public board’s direct supervision over Palomar’s top management. The contract instead gives the private firm, Mesa Rock, authority over the operations of the district and both of its public medical centers.

And as we discuss further in the following section, a key aspect of this agreement will also block public access to important records—particularly those created during top management’s deal negotiations with potential strategic partners in healthcare as well as other industries.

Now, why in the world would Palomar’s board enter into this sort of agreement instead of simply replacing its top management? To understand the factors driving this deal, one first needs to understand California’s Public Records Act.

Originally passed in 1968, this legislation safeguards the accountability of government to the public by providing prompt access to public records. According to the Voice of San Diego, Palomar Health is subject to the Act because all public healthcare districts in California are “created by the public, their governing boards are voted in by the public, and they are partially funded by the public.” Specifically, Palomar receives millions of dollars in property taxes every year, like most public healthcare districts in California and many others across the nation.

However, the Mesa Rock deal’s proponents argue that unrestricted public access to records handicaps organizations like Palomar, which could be losing millions of dollars as a result. According to the Union-Tribune:

Attorneys who explained the Mesa Rock deal Thursday said that many private organizations are reluctant to build deep relationships with public entities like Palomar because of the fear that doing so will put private information into the public realm, perhaps allowing competitors to discover trade secrets through public records requests.

In other words, what this explanation suggests is that private medical providers who also serve the San Diego region, like Kaiser Permanente, Scripps Health, and Sharp HealthCare don’t want to negotiate partnership deals with public districts like Palomar. That’s because the executives at private corporations like those fear that the records of their negotiations with the leadership of public entities could expose their trade secrets to competitors.

But the Mesa Rock proponents seem to believe that Palomar could potentially avoid bankruptcy through negotiating cost-saving or, in some cases, potentially lucrative collaborative affiliation agreements with private providers like those.

For example, supporters cite a 1991 deal where Sharp HealthCare leased all the assets of the Grossmont Healthcare District. Grossmont is another huge public health district serving 750 square miles of eastern San Diego County, which includes the 536-bed Sharp Grossmont Hospital in La Mesa. A similar leasing deal with a private company for a portion of Palomar’s assets could resolve the district’s financial crisis.

Palomar hired John Kern, a San Francisco attorney with the law firm Holland & Knight to write the Mesa Rock contract. Kern argued to Becker’s Hospital Review that the agreement would enable Palomar to better compete with for-profit hospitals:

It’s simply not realistic for an institution like Palomar to sustain and compete with for-profit hospitals in its region without making some type of creative pivot. And so the idea of the agreement is to partner with an outside nonprofit organization that will then hire Palomar’s executive team. And then through that vehicle, be able to enter into affiliation relationships with other regional health partners that, under the current public structure, it could not.

Under this agreement, Mesa Rock as a private, nonprofit entity wouldn’t be subject to the Public Records Act. And Palomar’s top management will no longer work directly for the district’s elected board, but would instead work for Mesa Rock under the new agreement.

As a result, the records from those executives’ work product—including any trade secrets they learn about—would mostly end up shielded from public view and blocked from disclosures under legal mechanisms such as Freedom of Information Act requests. Palomar’s executives argue that such assurances of privacy would encourage executives at private companies to negotiate with them, and in turn, affiliation agreements like Grossmont’s could happen quickly.

However, opponents wondered why recent and current partnership agreements between Palomar and private medical providers weren’t rejected on privacy grounds. For example, Palomar contracts with Rady Children’s Hospital to operate pediatric and neonatal care units. Also, Kaiser Permanente doctors were allowed to treat Kaiser patients at Palomar facilities until just recently under a contract lasting for several decades.

But other potential partnership deals fell apart because private providers didn’t want to contract with a public hospital like Palomar, according to Kern.

“They imagine, I think, increased regulatory scrutiny,” Kern told the Union-Tribune. “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.”

Despite Kern’s arguments, commenters at the board’s meeting prior to the vote like Dr. James Schultz argued that neither the public nor Palomar’s medical staff would benefit from the deal. Dr. Schultz currently works as the chief medical officer at a community health center after his previous career as one of Palomar’s physicians.

“I don’t believe this decision is in the best interest of the residents. This essentially sidelines the medical staff from any influence over management,” Schultz said. He also argued that the deal could attract scrutiny from the California Medical Association.

Other commenters who testified at the meeting raised questions about top management’s accountability under the new arrangement, since that C-suite team would not directly work for the elected board any longer. Besides retaining authority over budgets, the board maintains the authority under the agreement to end the healthcare system’s involvement with Mesa Rock, and it could also veto Mesa’s choice for a new CEO. However, the board would not retain the authority to replace a CEO who wasn’t performing up to expectations.

“You cannot take away the rights to hire and fire the CEO,” said one of only two board members who voted against the proposal, John Clark.