Therese WarehamHospitals and health systems nationwide are rapidly redefining their strategies due to the industry’s move from a volume-based to a value-based model.

As sickness care transitions to health care, a shift is occurring, with the focus changing from inpatient admissions to observation stays and outpatient care. Inpatient utilization rates are declining in many areas of the country. Those declines are expected to continue and will result in flattening or even declining revenues for many organizations moving forward. So while the overall financial position of the healthcare sector and provider balance sheets remain strong, an unsustainable trend is emerging: Expenses are growing faster than revenues, and as a result, negative outlooks from the rating agencies have increased.

To address this challenge, hospitals and health systems are working to reduce costs, increase efficiencies, and revise the way they deliver care. Many organizations are restructuring and rationalizing their businesses and care delivery networks. The industry is seeing a high number of consolidations and affiliation agreements in a variety of forms, because larger integrated health systems are seen as being best able to meet the strategic, financial, and intellectual capital requirements of the new care delivery and payment system. 

Indicators of long-term sustainability

To prepare for the new business model, hospitals and health systems must focus on key initiatives, including ensuring strong governance and management, making long-term investments in IT and physician recruitment and retention, and operating as efficiently as possible while delivering high-quality care. This is a multifaceted problem that requires both managers and board members to possess a high degree of organizational skills, capability, and focus. In many cases, it also means fundamentally changing the way care is delivered and health is managed.  

Access to capital to fund such initiatives will be critical. Direct lenders, investors, and rating agencies are closely examining and redefining indicators of an organizations’ long-term sustainability. They want to ensure that capital investments are sound and that providers will be able to meet their debt obligations.

Here are some of the questions being raised:

  • Will a provider of the future need to offer inpatient and outpatient care, own a health plan, and manage a population’s health?
  • Do organizations need to participate in risk-based contracts to succeed long term? 
  • Regarding specific organizations, is there alignment between the organizational goals and goals of the physician enterprise?
  • Does the organization have the capital capacity to adapt to the changing business model?

Effect of Industry Uncertainties on Market Volatility

Volatility in the capital market is making it more difficult for organizations to secure needed financing. Interest rates on tax-exempt fixed-rate bonds are increasing, based primarily on fears that overall market rates will rise as the Federal Reserve “tapers” its bond purchasing program. Interest rates on variable-rate bonds remain low, resulting in an increase in hospitals’ issuance of variable-rate debt, but floating-rate notes that lock a spread several years out on the yield curve have become more expensive due to uncertainties about the future course of the industry.

Some public municipal market refunding transactions have occurred, but direct placements are easier to implement because they do not require public disclosures. Taxable debt is still an option for many hospitals and health systems, but the demand is more volatile and concentrated on organizations with higher credit ratings.

Moody’s Investors Service has applied a negative outlook for the industry again this year, because operating performance is deteriorating slowly, in spite of stable balance sheets. Fitch and Standard & Poor’s both have issued stable outlooks for health care for 2013. Across the three agencies, credit upgrades have significantly declined during the last nine months. 

In fact, more credit ratings have been affirmed than either upgraded or downgraded, but the number of negative outlooks has increased. Many consolidations have resulted in a greater percentage of credits falling into the A category and above as lower-rated credits join organizations with higher ratings.

Providers, lenders, rating agencies, and other stakeholders all are trying to answer the same question: What will it take to succeed in the future? At the end of the day, success can be measured by an organization’s ability to repay its debt over five, 10, 20, or 30 years. To prepare for the new business model, healthcare leaders must find a way to tell “their story,” including how they plan to meet their debt obligations over the long term while continuing to meet healthcare needs in their communities.

Therese Wareham is managing director and CEO at Kaufman, Hall & Associates, Inc.

Publication Date: Tuesday, November 26, 2013