Healthcare Pt. 2: Show Me The Incentive

"Show me the incentive, and I'll show you the outcome." 

— Charlie Munger

The truth about the runaway costs of healthcare turns out to be a little more complex than any single source we've named. Hospitals, insurers, private equity, administrators, pharmaceutical companies… pull the thread on any one and we land in the same overextended, bloated, extractive system.

Nobody in this system gets paid more for making us both healthier and cheaper to treat. We are living with a $5.3 trillion industry whose incentive is to increase revenue instead of preventing illness while reducing cost.

For a widening slice of Americans, healthcare is a source of financial stress. As we discussed last week, 48% of working-age adults have gone without needed care because of cost. That means a prescription left unfilled, a test postponed, a specialist never seen.

The problem, as I see it, is misaligned incentives, deeply entrenched special interests, and a system that often ignores stakeholders (as in patients and payors). 

Show Me The Money

One of the clearest examples of how misaligned incentives work is what happens when a hospital or nursing home sells the real estate it operates out of. An investor (often a REIT) buys the real estate and leases it back to the operating company.  The valuation of the real estate often has less to do with the actual land and buildings, and more to do with the value of the operating licenses and permits.  And the lease amount is tied to what the REIT paid to purchase the property, not to what the facility can afford to pay.

Say you own a nursing home built in the 1980’s.  What’s the building worth?  Picture a building that looks similar to a college dorm (not a fancy new one–more like the boxes you and I lived in at one point, many decades ago).  There are long, straight hallways with single rooms on each side.  They have a bathroom and a closet, but nothing else.  I suppose the building could be converted into a studio apartment complex.  Other than that, there aren’t many uses. 

In other words, the building isn’t worth much outside of being a nursing home.  Yet, you could probably get a healthcare REIT to give you around $10 million for the real estate.  If you have a mortgage, that gets paid off in the sale and comes out of your proceeds.  What’s left is yours, to do with what you wish.  There is often no restriction on this type of transaction, and no requirement that the funds be put back into the operation. It is a cash-out financing. And this attracts the financial engineers.  

Sale-leasebacks often do nothing good for patient outcomes or reducing the cost of care. In Illinois researchers tracked 83 nursing-home real estate transactions over two decades. After the facilities sold their properties and leased them back from companies under common ownership, real estate spending rose $1,744 per bed per year — 42% — while roughly $32,827 per bed of asset value got shifted off the nursing homes' balance sheets.^[1] 

Private equity takes it a step further. A nationwide study covering 4.2 million Medicare patients and roughly 12,400 for-profit nursing homes found that 1,674 facilities were acquired by PE firms across 128 deals. Buyouts brought more debt, higher interest payments, new fees, and sometimes real estate sales that turned property into cash while leaving the nursing home with rent. Interest payments rose 224%, and researchers found an 11% increase in mortality, even as PE-owned facilities admitted lower-risk patients, amounting to roughly 22,500 additional deaths over twelve years.^[2]

Another example is when private equity firm Carlyle bought nursing home chain HCR ManorCare for $6.3 billion, mostly with debt. Four years later, it sold the underlying real estate for $6.1 billion, leaving ManorCare paying rent on buildings it used to own. By 2018, to no surprise, the nursing home entity was bankrupt.^[3] 

And sometimes you don't have to cut anything at all. Just change how the exact same service gets billed. A hospital buys a physician practice, and suddenly their services are considered “hospital outpatient,” and Medicare's payment for a lumbar epidural injection jumps from $255.89 to $740.88. ^[4] 

The financial engineering in health care keeps getting more sophisticated. My friend Jared Dillian runs a website called Short Private Equity.  On it, he cites an investigation that found more than 500 joint ventures between private equity-backed companies and nonprofit healthcare providers. Instead of buying the nonprofit outright, a PE-backed company can “partner” with it. Leaving the nonprofit name and structure in place while taking a major economic stake in the business.

For example, Duke LifePoint Healthcare. Duke's name comes first. But PE-backed LifePoint owns 97% of the venture. In other words, private equity doesn't necessarily have to buy the nonprofit to get most of the economics. Here’s how they do it.

You might think there's nothing nefarious about it, but equity groups typically don’t show up out of altruism. Many states are concerned enough that they're writing laws specifically aimed at limiting private equity's role in healthcare.

Regulators Can’t Keep Up

Lawmakers are erecting guardrails on private equity across the economy — with healthcare a particular focus.

Massachusetts had a reason to move. Private equity firm Cerberus bought six nonprofit Catholic hospitals in Boston for $246 million in 2010 and renamed the chain Steward.^[5] In 2016, Steward sold its hospital real estate to Medical Properties Trust for $1.25 billion and leased the buildings back. The deal returned Cerberus’s original investment, while leaving Steward paying rent on buildings it once owned. Cerberus ultimately exited Steward in 2021 with roughly $800 million in profit.

Steward filed for bankruptcy in May 2024 with more than $9 billion in liabilities. Roughly eight months later the state barred acute care hospitals from leasing their main campus from a REIT.[6]

I could keep going. About a dozen states have now enacted laws aimed specifically at private equity in healthcare, and roughly as many more have bills in motion.

They can ban sale-leaseback transactions. They can require disclosures and reviews before an acquisition. But the financial engineers are always going to be three steps ahead of the regulators. And the multitude of other perverse incentives remain. 

All of which is to say private equity is a clear symptom. As long as there's money to be made off a system that doesn't reward keeping people healthy and cheap to treat, somebody will find the trade, and when a state closes one door, they'll find the next one.

So What’s the Fix?

The pharmaceutical and health products industry is consistently named as a top spender of lobbying dollars in the US.  So are insurance companies and health care providers (nursing homes and hospitals). They have your representatives’ ears.  This, plus the incredible complexity and size of our healthcare system, make it unfixable as it is. 

But there’s hope.  The “fix” is to move as much healthcare as possible outside of the current broken system.  Technology will play a big part.  Changing behaviors and outright circumventing of the existing system could also drive down costs.

The good news, is slowly, it’s starting to happen. The CT scan that screens for lung cancer is covered with no co-pay and no deductible for anyone eligible, yet fewer than one in five eligible adults have had one.[7][8] Colon cancer caught late can cost several times more to treat than when it's caught early.^[9] Smartwatches are detecting otherwise silent heart problems; in one recent randomized trial of adults 65 and older at elevated stroke risk, they detected new atrial fibrillation at more than four times the rate of standard care.[10] And AI is beginning to translate the lab and pathology reports sitting in patient portals into language ordinary people can actually understand.^[11] AI won’t replace doctors or radiologists – it will help clear the backlog and boost efficiency, which will bring down costs.

The state of Connecticut learned decades ago, the way to get the cost of nursing home care down is to keep people from going into nursing homes.  In 2004, CT had 29,801 nursing home beds.  As of a year ago, bed count is at 22,173—a reduction of 26%.  Believe me, my home state didn’t get any younger over the past twenty years.  If anything, the average age is higher today.    

Incentives were put in place to keep folks in their own homes longer, with home-based healthcare and earlier interventions, which is a lot cheaper than institutional care.  Now, CT is not exactly a bastion of forward-thinking government innovation.  Their Medicaid expense was causing a state-wide budget crisis. 

They had to make a change.  And here’s the hard part, that they got (mostly) right: instead of trying to keep all stake holders whole and bail out operators and REITs, several facilities were allowed to go bankrupt and were closed.

My broader point here is, as behaviors change, and as new technologies in healthcare reduce the need for the legacy healthcare system… let things run their course.  Let the bankruptcy system do its thing. 

We will always need hospitals, and perhaps insurance companies, but do we need as many as we have today, if technology improves healthcare outcomes and delays (or prevents) the need for critical care?  If we try to keep all stakeholders whole, we’ll never get the costs down.  That means some investors will feel some pain. 

To be clear, I'm not rooting for hospitals to close, especially in rural areas where the nearest ER may already be an hour away. The goal is to build better, cheaper alternatives that make some of the old capacity unnecessary, not eliminate capacity before there's something better to replace it.

Doing this will be difficult, but far easier than trying to shift the beast to something like a single payor system.

In the meantime, we can and should fine tune the system.  Get incentives in line with the goals of healthier patients and lower cost. 

I once heard Kyle Bass present on the need to get US pharmaceutical costs down.  He said pharma companies were abusing loopholes in the patent system to extend the life of their drug patents, which prevents competition.  Someone in the audience said, “but their margins will go down.”  After Kyle stopped laughing, he said, “cry me a river.” 

We can streamline the medical billing process in this country.  We can even change the incentives for insurance companies to be more aligned with patient outcomes, if politicians grow a spine, but to really get costs down and “fix” the problem, we need to encourage Schumpeter’s creative destruction.  Bring down roadblocks to innovation.  Embrace AI’s contributions to diagnosis.  Reduce costs tied to drug development, and maybe join the rest of the world in negotiating drug costs.  And strive for cures vs. treatments.

That’s the only potential path to improvement I see for healthcare.

Where This Leaves Us

Cheaper tests, better technology, and more accessible information can start to change that equation. And they may have to. A middle class watching housing, education, and healthcare outrun what it earns doesn't simply absorb the difference forever. Eventually, something gives.  I think we are seeing the start of that in today’s early primary results.

We’ll dig into the ramifications of all of this further next week. In the meantime,

Let me know what you think — reply to this note or drop a comment.

Thanks for reading!

Ed D’Agostino

Partner & COO

^[1] https://www.nber.org/papers/w32258

^[2] https://www.nber.org/papers/w28474

^[3] https://www.bostonglobe.com/2026/07/30/business/steward-health-care-cerberus/

^[4] https://www.medpac.gov/documents/reports/june-2023-report-to-the-congress-on-medicare-payment-policy.pdf

^[5] https://app.leg.wa.gov/billsummary?BillNumber=2548&Year=2026 

[6] https://www.reuters.com/business/healthcare-pharmaceuticals/bankrupt-steward-health-puts-its-hospitals-up-sale-discloses-9-bln-debt-2024-05-07/

[7] https://www.uspreventiveservicestaskforce.org/uspstf/about-uspstf/methods-and-processes/procedure-manual/procedure-manual-appendix-i

[8] https://pressroom.cancer.org/2025-lung-cancer-data

^[9] https://www.tandfonline.com/doi/full/10.1080/03007995.2022.2047536

[10] https://pubmed.ncbi.nlm.nih.gov/41569211/

^[11] https://pathology.duke.edu/news/patient-friendly-pathology-reports-transform-patients-access-information