Andrew Donahue: An open letter to Congress on nonprofit hospital finances

There’s a lot of bad information out there on nonprofit hospital finances. Part of the problem is run-of-the-mill scapegoating — stakeholders with an agenda using our business complexity to muddy the water. Part of the problem is classic misuse of information — good people with good intentions making the wrong assumptions. And part of the problem is our own failure to tell our story — hospital finance leaders typically move from one facility crisis to the next with little time in between to manage reputation.

Whatever the reason, U.S. healthcare’s problems are too big — and your time is too limited — to continue to work with the wrong assumptions.

Nearly 8 in 10 hospitals operate at or near break-even

Not all hospitals are the same. There are 6,120 across the United States.^a Of these, only a minority are investor-owned, chugging along with operating margins of 10% or higher that you see on the front page of The Wall Street Journal. These systems return tremendous value to their communities and shareholders. But don’t let their prime geographic locations and/or access to capital fool you. The vast majority of U.S. hospitals are governmental or nonprofit facilities that closed their books last year with an average annual operating margin of 1.2%.^b

That’s not a lot. To put that into context, for a large nonprofit health system like Indiana University Health, which employs 38,079 teammates annually at a cost of $4.6 billion (salaries, wages and benefits), an operating margin of 1.2% would have generated a profit of $104 million in 2023.^c That’s it. That’s not even enough to pay the annual salaries of the Indiana Pacers’ 15-man NBA roster ($127 million).^d

The reason community hospital margins are so tight is simple. At a presentation during HFMA’s Annual Conference in 2023, Fitch Ratings described it as the “75/75 conundrum.” About 75% of nonprofit health system revenue comes from Medicare, Medicaid and self-pay patients, meaning payment that is fixed, flat and/or declining year-over-year. Meanwhile, about 75% of health system expense — salaries, wages, benefits (50%) and supplies/drugs (25%) — is permanently elevated and/or continues to rise, due to generational staffing shortages and historic inflation.

Fundamentally, this business model does not work. It is not sustainable. If not for governmental subsidies and/or health system intercompany transfers, most U.S. hospitals would operate in the red.

Audited financial statements are the best way to measure hospital profitability

Understandably, you need to keep your finger on the pulse of your local hospital’s fiscal health. At the same time, it can be confusing to know where to look. Too often, researchers, academics and the media quote Medicare cost report data and the IRS Form 990 to draw conclusions about hospital profitability. If only it were that simple.

Unfortunately, neither of these technical administrative tools are designed for that purpose. The former is a regulatory filing for reimbursement allocation, and the latter is an informational form for community benefit surveillance. The limitations of both have been outlined by HFMA’s Principles and Practices Board in a 2023 report, Assessing reality in healthcare financial information.

But there’s good news. Each year, the top accounting firms in the country examine nonprofit hospital financial statements (and interview those who prepare them) to validate their accuracy. These audited financial statements use the same accounting standards (i.e., generally accepted accounting principles [GAAP]) that the Securities and Exchange Commission requires of publicly traded companies. Not only does GAAP represent the gold standard for financial reporting and accountability; its core principles of uniformity and consistency also allow for a degree of comparability across diverse states, localities and congressional districts. These audited statements represent a treasure-trove of information for you and your staff, and most of their pages include highly readable narrative text (not obscure numbers and jargon).

Avoid getting excited about cash and investments

As you begin to flip through the audited financial statements, it’s not unusual to fix your eyes on a single fact or figure. For instance, Sen. Tammy Baldwin (D-WI) recently wrote a letter to Ascension Health — one of the nation’s largest nonprofit health systems with 134,000 employees — arguing as follows:

At this year’s J.P. Morgan Healthcare Conference, your CFO highlighted Ascension’s $18 billion of cash and investments. This number raises questions about why Ascension, a mission-driven health system with non-profit status, is not prioritizing reinvestment into serving vulnerable communities and its own operations—which should include increasing pay and improving working conditions for its burned out and overextended healthcare workforce.”^e

Every number has a backstory. In this case, characterizing $18 billion of cash and investments in this manner is problematic for a few reasons:

• First, $18 billion may seem like a lot, at first glance, but it’s not much relative to Ascension’s total annual operating expense (about $30 billion). In other words, $18 billion would only cover two quarters of operations for Ascension (half of one year).
• Even so, it would be imprudent to view $18 billion of cash and investments as an emergency or “rainy day” reserve because capital markets (lenders) typically require nonprofit health systems to retain a certain level of cash and investments as a lender safeguard. In fact, it is this external “liquidity requirement” that usually determines the exact dollar amount of cash and investments that a nonprofit health system will retain (and, yes, that requirement could be as high as $18 billion).
• Finally, of critical importance, as business operators, hospital finance leaders always want to avoid any operational dependency on stock market returns (e.g., to make payroll), fickle as they are.

All of those cranes in the sky don’t mean much either

There’s a great deal of scrutiny these days on hospital mergers, acquisitions and healthcare prices. On the surface, that kind of scrutiny may feel appropriate. We’ve all learned the hard way in America that bigger isn’t always better because, for example, it can lead to less competition, inferior service and higher prices. A healthy degree of skepticism has developed over time. So it’s reasonable to look up in the sky and wonder, “If things are so difficult for hospitals, why are they expanding so much?”

That is a good question. But it’s also important to understand the true impetus for growth in nonprofit healthcare. If you don’t, then on any given day before a vote or a committee meeting, you may run the risk of drawing a false equivalence between nonprofit facilities and various investor-owned players.

Governmental insurance pays nonprofit hospitals below their actual cost. In turn, to offset these losses — and to subsidize services for all of Main Street — nonprofit hospitals negotiate with for-profit private insurance companies for higher payments. Usually, however, these publicly traded entities resist these requests for higher payment unless the health system making the request is essential to their network (too big to ignore).

Put another way, expansion in nonprofit healthcare is not motivated by your traditional Monopoly board-game logic (i.e., ruthlessly putting one’s opponent out of business by owning Mediterranean Avenue, Boardwalk and everywhere in between). It is motivated by a need to survive, which won’t be possible without rate increases from for-profit health insurers.

What it all means

None of this is to say that hospitals deserve a pass. But there is more to nonprofit hospital finances than meets the eye. The next eight years will make or break America’s long-standing community healthcare system (i.e., demographic/volume headwinds, technological innovation and new disruptive competition). If any nonprofit hospital happens to serve a large swath of your constituents — or represents one of your largest employers — there has never been a more important time to understand their books. 

Footnotes

a. American Hospital Association, “Fast facts on U.S. hospitals, 2024,”  Updated January 2024.
b. Based on Kaufman Hall & Associates, LLC, National hospital flash report, January 2024.
c. Numbers were drawn from Indiana University Health’s consolidated financial statements from 2023.
d. Spotrac, “Indiana Pacers 2023-24 salary cap,” 2024.
e. Baldwin, T., Letter to Joseph Impicciche, Unites States Senate, Feb. 13, 2023.
f. For a glance at the financial performance of some of these investor-owned industry leaders, go to finance.yahoo.com and, under “Quote Lookup,” search for UNH, ELV and CI (i.e.,UnitedHealth Group Incorporated, Elevance Health, Inc., and The Cigna Group, respectively).