Hospital financial experts predict margins will continue to soften in 2017.

May 19—Expense growth at not-for-profit and public hospital in 2016 surpassed revenue growth, according to a new analysis of preliminary sector financial medians by Moody’s Investors Service.

Moody’s annual medians analysis showed almost a complete reversal of 2016 expense and revenue growth compared to 2015, with annual operating expenses rising from 6.2 percent in 2015 to 7.5 percent last year, while annual operating revenues dipped from 7.4 percent in 2015 to 6.6 percent in 2016, according to the analysis (login required) released May 16.

Moody’s attributed the rise in expenses to escalating labor and pharmaceutical costs, changes in reimbursement, and uncertainty in the state health insurance exchanges.

The credit rating firm’s report found median hospital operating margins were 2.7 percent and median operating cash-flow margins were 9.6 percent, both down from 2015.

“The reversal in trajectory of profitability demonstrates the stress of lower reimbursement and the material rise in expenses,” the report found. “While demand trends remain generally positive, the report found that the sector is experiencing an overall softening in operating performance and liquidity measures compared to last year’s medians.”

The 2016 median operating cash flow fell to $75.9 million from 2015's median of $76.4 million. And 2016 median days cash on hand dropped to 204.8 from 223.4 in 2015.

Moody’s analyzed audited FY16 financial statements from150 debt issuers representing 37 percent of all rated entities. Beth Wexler, a vice president for Moody’s, said the trends captured in the preliminary analysis of hospital medians historically hold true through the final analysis of total audits later in the summer, with a few exceptions.

While Moody’s is “not suggesting the sky is falling, we’re seeing a softening from the peak year of performance in 2015, a really robust breakout year for the industry,” Wexler said in an interview.

The 2016 financial performance data tells her that hospitals face potentially troubling trends.

“In spite of the fact that hospital organizations have taken control of expenses and merged to gain leverage with payers, their efforts were not sustainable,” Wexler said. “Many factors remain out of their control and will continue to pressure the industry.”

Martin Arrick, managing director and analytical leader for U.S. Public Finance for Standard & Poor’s, said his firm will release its medians report in July or August.

S&P attributed the “softening” to a “wide range of incremental pressures, including a baselining of the Affordable Care Act’s Medicaid business, higher labor costs, expense pressures and flattening patient volumes after several years of ACA-driven growth,” Arrick said.

Arrick also sees no collapse in the hospital sector.

“Our outlook is still stable. We think that business in general, the things supporting the sector—stronger balance sheets that have improved and recovered since the 2008 recession and solid business positions—remain strong,” said Arrick in an interview.

S&P issued a stable outlook for the non-profit sector in a January report, but noted that legislative risks could put it “a pen stroke away from unprecedented change.”

“And the biggest soft spot, an operating weakness, is not uniform or systemic,” Arrick said. “Management teams are doing a good job of preserving overall financial strength.”

Kevin Holloran, head analyst for Fitch Ratings Service’s non-profit healthcare group, said his agency’s report also will come later this summer when all of the audits are completed.

Personnel Focus

Hospital leaders will need to focus more on “blocking and tackling” and ongoing efforts to seek out efficiencies, reduce costs, and find ways to grow their business, Holloran said in an interview.

“The lesson here is that while it may not affect your hospital yet, it eventually comes your way,” he said. “If you aren’t thinking about salary and wage expense and how to improve your retention and recruiting of doctors and nurses, you had better be.”

Richard Gundling, senior vice president for healthcare financial practices at HFMA, said the Moody’s preliminary medians report findings are consistent with what HFMA has seen in the industry.

“Rising cost structures are putting pressure on the bottom line,” Gundling said in an interview. “One of HFMA’s top priorities is working with our members to look at costs in a different way. Revenues just won’t be increasing at the same pace. This is the ‘roll up your sleeves’ work we knew was coming.”

Lilly Scher, vice president of Eaton Vance Investment Managers, said she concurs with Moody’s preliminary medians analysis.

“In addition, we’re seeing shifts in payer mix, from commercial into Medicaid,” Scher said in an interview. “It’s not rampant, but a worsening in payer mix contributes to top line depression.”

Scher noted the Moody’s observations were retrospective.

“But it’s important for hospital leaders to think prospectively,” she said. “If the American Health Care Act [AHCA] is signed, the paradigm will have shifted away from increased access and coverage to reduction of federal outlays. You can expect that will have very negative consequences for hospitals. And the repeal of the Medicaid program [expansion through the Affordable Care Act] marks a huge shift from an open-ended federal entitlement to a block grant with specific caps placed on Medicaid funding.”

Jonathan Saylors, managing director for Huron Consulting, said his firm has seen “across the board cost pressures. We’re beginning to see big name hospitals undergoing big cuts. No one’s safe anymore. The new normal is lower margins and greater focus on costs.”

Shifts in payment models and care settings also are becoming more challenging, Saylors said.

“Some product lines like orthopedics are moving out of hospitals into outpatient settings,” he said in an interview. “The overall message is we don’t know what’s happening in Washington. We know [the Centers for Medicare & Medicaid Services] will continue to shift towards value-based reimbursement and commercial payers will not be far behind.”

Historic Trend

David Muhlestein, chief research officer for Leavitt Partners, characterized the decline as part of a historic trend.

“I see this as a regression towards the mean,” Muhlestein said in an interview. “The not-for-profit sector typically operates within a 2 percent to 3 percent margin. Once it gets much higher—which it has been for several years now—it eventually tends to drop a little.”

During good economic times, hospitals spend more, hire more staff and undertake capital expansions, he said.

“Their margins go down as their expenses go up and this is just another example of that,” he said. “It’s not yet a cause for alarm. As long as hospitals remain in the black, they can be pretty viable going forward. When hospital margins average below 1 percent it gets problematic. While some hospitals are suffering, collectively, the industry is doing quite well.”

He predicted that next year expense growth will rise at a slower pace as hospitals reduce capital investments and impose hiring freezes to decrease their work force.

Muhlestein advised hospital financial leaders to perform critical assessments of their organizations and tighten their belts.

“National trends are the averages of all local trends and they need to understand local factors to foresee what’s coming in their markets and prepare for that,” Muhlestein said.

Mark Taylor is a freelance writer based in Chicago.

Publication Date: Friday, May 19, 2017