Lisa Goldstein

Not-for-profit hospital revenue growth has declined to its lowest level in two decades.


At a Glance

As revenue growth declines among not-for-profit U.S. hospitals, Moody's anticipates challenges to revenue from the following:
 

  • Medicare  
  • Medicaid  
  • Commercial payers  
  • Patient Volumes
  • Uncompensated care  
  • Transition to ICD-10  
  • Fee-for-service and bundled payment  

Top-line revenue growth is falling at many not-for-profit hospitals, presenting a difficult challenge to hospital management teams and supporting Moody's negative outlook for the sector.a Hospital downgrades will likely increase in the short term unless expense reductions and productivity gains compensate for stagnant or weak revenue growth. With hospitals facing reimbursement pressure from all payers-Medicare, Medicaid, and commercial health insurers-and declining volumes resulting from a persistently sluggish economy, many hospitals are reviewing every aspect of their operations to make fundamental changes to their business model. These efforts will stave off rating downgrades at better managed hospitals, but will likely prove insufficient at others to stave off credit deterioration over the longer term.

Moody's expects the following challenges to revenues.

Medicare. Despite an uptick in payment rates for 2012 (the Medicare program recently announced a 1 percent increase in rates for federal fiscal year [FFY] 2012), funding pressures and rate reductions are inevitable in coming years as Washington seeks to reduce the deficit and rein in Medicare costs.

Medicaid. Hospitals will experience widespread rate reductions caused by federal budget reforms as well as funding pressure at the state level as lawmakers continue to grapple with budget challenges.

Commercial payers. Rate increases will decline as payers face financial challenges and increased regulation, reducing hospitals' ability to cost shift.

Patient volumes. Inpatient admissions will flatten while lower-paying 24-hour observation stays increase.

Uncompensated care. Initially, uncompensated care is likely to increase, given stubborn unemployment rate and employers' efforts to discontinue or reduce healthcare benefits, but over the longer term, it should decrease due to greater coverage under healthcare reform.

New disease diagnosis classifications (ICD-10). The transition will likely disrupt revenues in 2013 unless management teams start preparing now.

Fee-for-service and bundled payment. Simultaneous management of two very different payment schemes will impede revenue management.

Median Hospital Revenue Growth Rate Falling

As depicted in the exhibit below, the median hospital revenue growth rate for FY10, at 4.0 percent (based on Moody's FY10 medians for 401 freestanding hospitals and health systems), is the lowest in two decades and is unsurprising given the payer pressures and lower volumes. In a small sample of unaudited interim FY11 statements, Moody's sees some stabilization of revenue growth but expects a further decline over the long term.

Exhibit 1

f_goldstein_exh1

The median expense growth rate for FY10 is also down, indicating that hospital management teams have responded to the revenue pressures thus far. However, additional expense reductions will be harder to achieve, and they will depend on more difficult strategies to change fundamentally how hospitals deliver care. Exhibit 2 depicts the median revenue growth rate from FY09 to FY10 for each state, based on audited financial statements for each rated hospital. Fourteen states show revenue growth below the national 4.0 percent median, and Moody's expects that number of states falling below 4.0 percent to increase in FY11. Indiana was the only state to show an actual decline in median hospital revenue growth in FY10.

Exhibit 2

f_goldstein_exh2

Medicare Reductions Inevitable Over the Long Term

The credit impact of Medicare cuts on hospital ratings is inevitably negative and will lead to more rating downgrades in the absence of significant expense reductions and productivity gains. Medicare constitutes nearly half (43 percent) of hospital gross revenues (see exhibit 3). Significant Medicare cuts to physician professional fee revenues, thus far avoided by Congress, remain a looming threat until a sustainable budget resolution is found. It is likely that as hospitals employ more physicians in preparation for healthcare reform and increase their professional fee revenues, they will face cuts from both hospital rate reductions and physician fee rate reductions.

Exhibit 3

f_goldstein_exh3

Medicare payment rates have been increased in every year from 1999 to 2010, but in FFY11, Medicare rates were effectively cut because presumed overpayments in prior years were netted out. This adjustment led to a payment decline in inpatient rates of 0.4 percent. Although the Centers for Medicare & Medicaid Services (CMS) recently announced a 1.0 percent increase in FFY12, that increase includes a reduction factor legislated under healthcare reform. Moody's expects Medicare rate reductions to hospitals in the coming years given the looming insolvency of the Medicare Trust Fund and the need to fund the mandated individual coverage stipulated under healthcare reform. Healthcare reform includes Medicare reductions of $155 billion over 10 years along with reductions to disproportionate share funding in FFY14. Furthermore, Medicare funding is in the cross-hairs of Congress given the federal deficit, and more cuts may be forthcoming as early as FFY13.

CMS is also reviewing potential overpayments to hospitals through the Recovery Audit Contractor (RAC) process. Numerous hospitals have been required to repay Medicare at the conclusion of the findings and appeals. RAC represents another pressure point on Medicare revenues for hospitals.

Medicaid Under Pressure from States' Fiscal Challenges

Most U.S. state governments continue to face considerable budgetary challenges. Not-for-profit hospitals have felt the brunt of these pressures as many states have reduced hospital Medicaid payment rates to balance their budgets, creating yet another strain on top-line revenue growth that hospital management must address. On average, Medicaid represents a moderate 11 percent of a hospital's revenue and therefore, Medicaid payment reductions have less of an impact on revenue than Medicare cuts for the average hospital. However, some hospitals are much more dependent on Medicaid because they treat a much higher share of Medicaid-eligible populations. Some of these providers face a higher likelihood of a rating downgrade.b  

The American Recovery and Reinvestment Act (ARRA) of 2009 provided states with enhanced federal funding that temporarily staved off deeper Medicaid cuts, but the June 30, 2011, expiration of the enhanced funding will lead to more severe Medicaid reductions. Many states have already implemented rate reductions as most states are essentially restricted from modifying Medicaid eligibility at this time as a means to reduce costs.

Many states are introducing Medicaid managed care organizations (MCO) to control costs. Medicaid MCOs typically receive a per capita payment from the state for each individual covered by the MCO's Medicaid program. Although Medicaid MCOs are not immune to the risk of reduced state payments, individual contracts between states and providers may make it difficult for states to implement midyear rate adjustments. In addition, state attempts to cut rates may be met with federal restrictions if the reductions limit access to care for Medicaid enrollees.

Experience has shown that there can be an adjustment period for both the state and the providers during the initial stages of a new Medicaid managed care program. Once a program is established, hospitals usually receive payments on a timely basis. Still, others experience revenue challenges well after a program is established.

Finally, CMS has also established Audit Medicaid Integrity Contractors (MICs), similar to the RACs. MICs perform audits of Medicaid providers to identify overpayments and inappropriate Medicaid claims. Although not as widespread as RAC reviews, MIC audits may also threaten revenue growth going forward.

Commercial Payers Face Declining Membership and Increasing Regulation

Moody's maintains a negative outlook on the health insurance sector.c An insurance payer's financial stress has a direct impact on hospitals' top-line revenue growth because a hospital's ability to cost-shift to commercial payers will be weaker. In past years, many hospitals have achieved higher rates from commercial insurers to subsidize losses on governmental payers.

Although health insurers' recent financial results have been very strong, it does not appear that those results can be maintained at this level. Recent earnings have been bolstered by lower-than-anticipated utilization as enrollees appear to have deferred medical care due to the general economic uncertainty. However, some insurers have reported a slight uptick in utilization in recent months. Adding to the pressure on the insurers' earnings are enrollment levels, which declined during the height of the recession as employers instituted layoffs or eliminated healthcare benefits. Many predict that membership will decline further as healthcare reform unfolds due to the establishment of state health exchanges as private employers discontinue healthcare benefits in favor of the exchanges.

Regulatory scrutiny surrounding premium increases has also increased. The Department of Health and Human Services (HHS) has announced that it will scrutinize all rate increases of 10 percent or more in the individual and small group market to determine if they are unreasonable. Also effective Jan. 1, 2011, two key provisions of healthcare reform-minimum medical loss ratio (MLR) regulations and changes to Medicare Advantage payment levels-may have a significant impact on insurers' financial results. The MLR regulations will, in effect, limit the profitability of the individual and group insured segments, while changes to Medicare Advantage payment levels could reduce health plan margins and membership. These pressures will undoubtedly result in tougher rate negotiations with hospitals.

To address these pressures, many health insurers are diversifying their service lines by adding third-party administrator (TPA) businesses, investing in technology to help consumers electronically navigate their benefits, and expanding into patient care. Recent examples include Humana's December 2010 acquisition of Concentra (provides physical therapy, urgent care, and occupational medicine) and WellPoint's announcement in June of its plans to acquire CareMore Health Group, a senior focused healthcare delivery program that includes 26 care center clinics. These strategies may put health insurers in direct competition with hospitals for outpatient revenues.

Economy Drives Volumes Down and Uncompensated Care Up

For any business, revenue growth is composed of two variables: rates (or price) and volumes. Inpatient admission volumes for not-for-profit hospitals continue to decline (see exhibit 4) with the growth rate actually turning negative in FY10. Reasons for the decline include a patient's decision to defer elective medical procedures due to the weakened economy, higher copays and deductibles required by employers who still offer health insurance or are discontinuing employer-provided healthcare coverage, a less-intense flu season, and a lower national birth rate.

Exhibit 4

f_goldstein_exh4

Also driving the decline in admissions is a shift in the classification of cases to observation stays that result in lower payment rates. Nearly all Moody's-rated not-for-profit hospitals are reporting large increases in observation stays in recent years. Observation-stay patients typically remain in the hospital for 23 to 48 hours, depending on the illness. The difference in payment rates between an inpatient admission and observation stay can be material, while the costs of providing the service are largely the same.

The depressed economy is also producing an increase in charity care as individuals lose their healthcare benefits or Consolidated Omnibus Budget Reconciliation Act (COBRA) coverage. Many hospitals are expanding their front-end registration process, in an effort to qualify more patients for some type of government funding or classify them as charity care rather than as a bad debt expense. Increased charity care may result in higher provider assessments for those hospitals operating in states with provider tax programs, and Moody's views this favorably.

ICD-10 Likely to Disrupt Revenues

The transition to the new International Classification of Diseases, known as ICD-10, from ICD-9 on Oct. 1, 2013, may disrupt hospital revenues as well. ICD-10 is the most current version of the diagnostic coding system that hospitals use to label a patient's medical diagnoses and submit these claims for services provided. ICD-10 codes represent a voluminous expansion of codes-to 69,000, compared with 13,600 under the current ICD-9 version. Hospitals risk delays in payment if ICD-10 codes are not used for services provided on or after Oct. 1, 2013, and will need to resubmit claims with the correct codes, which could greatly impair revenue flow.

Our observations indicate that most hospitals are not ICD-10 ready at this time, and CMS has stated that it will not push back the implementation date or provide any grace period for adaptation. If not properly handled, ICD-10 will have a direct impact on a hospital's Medicare case mix index, which measures acuity and affects Medicare reimbursement. ICD-10 will also be an expense issue as hospitals will need to spend resources to train their coders in ICD-10 and may need to purchase software upgrades that are ICD-10 compliant.

Managing Two Different Payment Schemes Will Be Challenging

Many hospitals are negotiating commercial payer contracts with fixed, or "bundled," payment terms, whereby the hospital receives a lump-sum payment that will need to cover all costs of a specific service before and after hospital care is provided. Medicare will begin piloting bundled payments in 2013.

This payment methodology is somewhat similar to the capitation model that many hospitals tried in the mid-1990s, which, during that period, often led to financially disastrous results. One of the main challenges hospitals faced was simultaneously managing two very different payment schemes: fee-for-service and capitation, both with different incentives and requiring different business models. Moody's envisions a similar occurrence today, as hospitals will need to manage both bundled payments and fee-for-service all at once.


Lisa Goldstein is a senior vice president, Moody's Investors Service, New York, N.Y., and a member of HFMA's Metropolitan New York Chapter (lisa.goldstein@moodys.com).


Footnotes

a. See Negative Outlook for U.S. Not-For-Profit Healthcare Sector Continues for 2011, Moody's Investors Service, February 2011.

b. See Medicaid Funding Cuts Add to Credit Strain for U.S. Not-for-Profit Hospitals, Moody's Investors Service, July 2011.

d. See U.S. Healthcare Insurers: Outlook Remains Negative, Moody's Investors Service, December 2010.
 

Publication Date: Thursday, September 01, 2011

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