The Troubling State of Not-for-Profit Hospitals’ Finances

A report published in August by Moody’s Investors Service painted a dismal picture of the current state of finances for not-for-profit hospitals and their prospects for the next couple of years. 

Problems

The median annual expense growth rate decreased from 7.1 percent in 2016 to 5.7 percent in 2017, as hospitals continued to tightly control labor and supply costs. However, annual revenue growth fell faster, from 6.1 percent in 2016 to 4.6 percent in 2017, despite increased merger and acquisition activity. This marks the second consecutive year that expense growth outpaced revenue growth, and this trend is expected to continue through 2019.

As a result, median operating margins dropped to an all-time low of 1.6 percent in 2017. More than 28 percent of hospitals posted operating losses last year, up from 16.5 percent in 2016. When a hospital incurs operating losses for multiple years, closure is a common result. Earlier this year, Morgan Stanley, in a study of all the nation’s hospitals, concluded that 18 percent of U.S. hospitals are at risk of closure or are weak performers. About 8 percent of hospitals (approximately 450 facilities) are currently at risk of closing. To put that figure in perspective, during the past five years, just 2.5 percent (150 hospitals) have closed. In addition, Morgan Stanley found that one in 10 hospitals is financially weak. 

Moody’s conclusion is that not-for-profit hospitals are on an “unsustainable path.” 

Causes

Not-for-profit hospitals’ financial woes can be attributed to a variety of factors. Because the vast majority of net patient revenue came from fee-for-service based payment models—such as DRG payment, fee schedule, or percentage of the chargemaster or list price—decreased payment rates adversely impacted revenue. To be clear, nominal payment rates did not decline—for example, Medicare’s Inpatient Prospective Payment System and Outpatient Prospective Payment System included nominal year-to-year increases in 2017—but the revenue mix between public and commercial payers did worsen for hospitals. Median Medicare and Medicaid payments as a percentage of gross revenue rose to 45.6 percent and 15.5 percent, respectively, in 2017, whereas much higher-paying commercial health plan payments slipped to 31.9 percent. Moreover, continuing a five-year trend, public payers’ share of hospital revenue is projected to increase, as more of the baby boomers—an obviously large demographic group—reach retirement age. 

Another cause is the continued shift from inpatient to outpatient care, including heightened competition from ambulatory facilities, such as physician offices and ambulatory surgery centers. Moody’s reported that median outpatient growth rates exceeded inpatient growth rates for the fifth straight year. In a recent address to the Commonwealth Club, Seema Verma, administrator of the Centers for Medicare & Medicaid Services, commented that Medicare clearly favors this inpatient to outpatient shift, seeking to avoid “downstream” expenses, such as emergency department (ED) visits and hospital admissions. 

Solutions

Not-for-profit hospitals have been attempting to cope with these financial challenges primarily with better management of labor and supply costs. But this strategy—while certainly prudent—may be reaching a point of diminishing returns. Lyndean Brick, president and CEO of the Advis Group, a healthcare consulting firm, has concluded: “This is no longer solely about expense reduction. If not-for-profits just focus on that, they will be out of business in the next few years.” ^a  

For many years, consolidation—in which small hospitals join a larger health system—has been a strategy to gain more leverage vis-à-vis payers, to achieve greater economies of scale, to obtain access to lower-cost capital, and to increase access to talent. 

Hospitals could also embrace the outpatient trend by opening urgent care facilities—which often then serve as feeders for appropriate ED visits and hospital admissions—and by adding physician-led ambulatory surgery centers, which are increasingly popular as well as profitable.

Specialty pharmacies also have proven to be lucrative revenue and profit generators for many hospitals and health systems. To brighten future prospects—and to ensure their survival— not-for-profit hospitals should continue to explore these and other opportunities.

Ken Perez is vice president of healthcare policy, Omnicell, Inc., Mountain View, Calif., and a member of HFMA’s Northern California Chapter.

Footnotes

a. Kacik, A., “Not-for-Profit Hospitals’ Cost-Cutting Isn’t Keeping Up with Revenue Decline,” Modern Healthcare, Aug. 29, 2018