5 factors that will make the next recession different from 2008

Hospitals emerged relatively unscathed from the Great Recession of 2008-11, according to a 2019 analysis.^a But that outcome was likely an anomaly, the analysis found, and a future recession is not likely to be so kind.

Based on a review of California hospital data from 2006 to 2013, just before the Affordable Care Act took hold, the analysis found that the 2008 to 2011 recession had little, if any, aggregate impact on hospitals’ operating financial performance. The data showed that although commercially insured patient volumes were adversely affected under the Great Recession, the impact did not extend to either revenues or operating margins. Staff were reduced, but only temporarily, and growth in salaries and wages accelerated. In fact, the 2008-11 recession heralded the beginning of improved operating profitability for hospitals.

The COVID-19 pandemic closed the door on this positive trend. As many hospitals began to halt elective surgeries and experience shortages of key supplies, the differences between impacts of the Great Recession and those emerging as a result of COVID-19 have made it clear that the looming recession will be much harder on hospitals compared with other downturns. Five factors figure to be significant.

1. Cost trend versus government payment

Since 2008, hospitals’ costs have risen at much faster rates than government payment. As a result, more hospitals have been losing more money on Medicare and Medicaid. Demographic changes, such as the increasing number of baby boomers aging into Medicare, compounded by the high probability of a greater share of the population qualifying for Medicaid, will likely lead to higher volumes of government-insured patients. In this environment, hospitals will need to cost-shift even more aggressively — if they can.

2. Commercial insurance rates

Over the past decade, commercial insurance rates have, on average, risen at or near double-digit rates. There is growing evidence among many hospitals and health systems that health plans have been able to exert much greater downward pressure on rate growth than in 2008, making cost shifting increasingly difficult for the provider organizations.

3. Volume of commercially insured population

One clearly adverse trend seen in the 2008 recession was a decline in commercially insured volume, and this trend will certainly be repeated during the next recession. A decreased ability to raise rates, compounded by a much greater reliance on cost shifting today, means any reduction in commercial volume will be magnified in its effect on hospitals’ bottom line.

4. Revenue cycle operations

Since 2006, the average case mix index of California’s hospitals has risen 36%.^b The population did not, in fact, become 36% sicker, although there is a distinct trend across the country toward increasing comorbidity especially among Medicare beneficiaries.^c Instead, the higher case mix index is probably the result of increasingly aggressive revenue cycle activities. Is this party over? Probably. As such, revenue cycle improvement initiatives cannot be counted on as a source of increasing revenue per unit of service to the extent they once were.

5. Increasing out-of-pocket exposure

Commercially insured and other patients must now bear a much higher burden of their healthcare expenses than they did previously, through both increased deductibles and higher out-of-pocket costs. With increasing unemployment, hospitals can expect a larger share of revenue will become uncollectable than during the previous recession.

Weathering the storm

There is no way to sugarcoat it: Hospitals, on average, will feel considerable pain in the expected coming recession. However, hospital leaders can take steps to help mitigate the impact.

The following are important proactive strategies hospitals should pursue to protect themselves against market distress.

Stress test the organization. As with the banking industry in the prior recession, it is imperative that the healthcare industry’s senior leaders and boards stress test their organization’s operating and capital positions. They should also insist on looking underneath these stress tests to understand their essential implications. 

Hedge against volatility. Borrowers who are planning a bond issuance in the future may wish to use forward starting swaps and rate locks to hedge their exposure to interest rate fluctuations.

Increase liquidity by selling peripheral assets and utilizing lines of credit. Although access to capital should continue to be strong for investment-grade health systems, some hospitals could experience working capital stress. In either case, liquidity is king in difficult times.

Evaluate covenants in debt agreements. Health systems could see a decline in the valuation of their investment portfolios and may be vulnerable to triggering a covenant violation based on liquidity measures, such as days cash on hand.  Debt service covenants which rely on operating performance could also be adversely affected.

Become serious about improving efficiency. This will be an extremely serious undertaking for many hospitals, and it will require having appropriately skilled clinical labor. Obstacles are that such staff resources are expensive and difficult to find, and many hospitals operate under collective bargaining agreements that may further limit labor flexibility. Hospitals may be able to address this issue to some degree by investing in technologies that facilitate greater employee and physician productivity.

Consider prospects realistically and act accordingly

In this environment, partnerships may be critically important to access resources, expertise and the experience of others that enable organizations to effectively serve their communities and respond to the challenges ahead. The types of partnerships hospitals and health systems could choose to pursue include the following:

• Health plan-provider partnerships, where the providers assume a greater share of risk and reward for the effective management of the cost and quality of care events or insured populations
• Partnerships with home health agencies (HHAs), where the providers contribute their often unprofitable HHA businesses to a joint venture operated by a partner that focuses exclusively on home health and personal care services
• Social services partnerships aimed at reducing the community’s long-term need for medical services through education and better environmental, nutrition and living habits
• Behavioral health partnerships where providers contribute their underperforming behavioral health services to a joint venture operated by a partner that focuses exclusively behavioral health
• Joint operating agreements or mergers with other hospitals or health systems in instances where the combination would clearly result in greater operational efficiency and lower cost of service

Footnotes

^a Rollo, R., “Recession and hospitals — It’s not how you think,” H2C News, Sept. 17, 2019.

^b California Open Data Portal, “Case mix index -1996-2018,” last updated Aug. 14, 2019.

^c See CMS.gov, “Co-morbidity,” Page last modified, April 5, 2020.