Amid positive signs financially, hospitals continue to grapple with high costs in labor and other areas

The latest financial metrics for the hospital sector reflect a period of increasing stability but also sustained challenges.

August financial data from more than 1,300 hospitals, as reported by Syntellis Performance Solutions, showed improvements in key metrics. The month-over-month increase in median operating margin was 3.5 percentage points, helping the year-to-date margin rise to 1.4% after it had fallen to 1.1% in July.

Operating margin has been positive for six consecutive months after spending more than a year in negative territory. Gross operating revenue increased by 8.7% from July and 7.8% year-over-year.

Volume trends showed positive signs. Year-over year increases for August were seen in adjusted discharges (6.5%), adjusted patient days (1.2%), operating room minutes (2.8%) and emergency department visits (0.9%). Big jumps were seen month-over-month, notably in OR minutes (13.7%), a welcome development after the pandemic-era volume shift away from surgical settings acted as a constraint on margins.

Average length of stay dropped by 4% year-over-year, indicating a reduction in high-acuity cases. The change in case mix also is seen in the revenue splits, with outpatient revenues increasing by 10%, compared with 4% on the inpatient side. Similar numbers were seen on a month-over-month basis.

Expenses continue to be unwieldy, rising by 4% year-over-year. Inflation has put nonlabor expenses in the spotlight, with year-over-year increases seen for drugs (7.3%), supplies (5.4%) and purchased services (3.8%). Supplies (1%) and drugs (1.4%) increased even when looking at expense per adjusted discharge, unlike total expenses (-2.8%) and labor expenses (-4.5%). Labor expenses overall rose by 3%, however.

Getting a handle on labor costs

It’s been apparent for a while that labor expenses will be pivotal to the long-term recovery of hospitals and health systems. Fitch Ratings recently noted that margins remain significantly lower than they were as recently as 2021, when the median margin among the agency’s rated credits was 3%.

“We expect weak margins to persist through 2023 and into 2024 due to an inelastic revenue model and higher labor costs due to still very tight labor conditions, even as operations broadly continue to gradually rebound,” Fitch stated.

In its hospital and ambulatory healthcare labor tracker for September, Fitch reported that average hourly earnings had decreased year-over-year for three consecutive months. At the same time, payrolls continued to grow — including by 14,100 in August and 8,400 in September for hospitals, with a year-over-year increase of nearly 150,000, per data from the U.S. Bureau of Labor Statistics.

In the overall healthcare and social assistance sector, job openings fell from 9.3% in March 2022 to 7% in July 2023. Quit rates in recent months dipped from 2.9% in May to 2.3% in July.

When looking at the full picture, Fitch stated, “Recruitment and retention efforts are reducing job openings, but with increased baseline staffing rates that likely have become the new normal for the sector.” In addition, reductions in reported cases of COVID-19, influenza and respiratory syncytial virus have decreased operational strain on the overall system.

As a result, Fitch’s conversations with clients suggest external contract labor utilization and rates have decreased compared with 2022. If those trends hold, “health systems should be able to manage through expense challenges over the next few years to improve profitability gradually,” Fitch said.

Above historical trends

Stability in the labor market carries a cost in that the new bar for wage rates is higher than it was before the pandemic. Fitch reported that average hourly earnings growth among hospital employees was 3.75% for July — far lower than the pandemic-era high (8.4%) but greater than during the decade preceding COVID-19 (2.3%).

Attracting and retaining staff will be key to alleviating margin stress, Fitch said. In terms of the impact on investment grades, the agency sees three tiers: highly successful recruiters; providers that struggle in recruiting, thereby maintaining a reliance on expensive external contract labor; and those in the middle, which will have some success in their recruiting but also will need to rely on contract labor.

A complicating factor in the labor market is the expectation that unionization in healthcare will become more prevalent. Regardless, the long-term outlook means providers will have to get creative strategically.

“Given the acute care sector’s reset of wages to a higher level, management teams are expected to turn to additional levers to improve operations,” Fitch wrote. Those mechanisms include:

• Payer contract negotiations
• Supply chain/purchased-service efficiencies
• Capacity optimization (via reductions in length of stay)
• Service line optimization
• Corporate overhead reductions
• Exits from financially challenging markets