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Investment gains masking health system operating margin difficulties
The combination of the Omicron surge, lackluster volume recovery, and rising expenses have contributed to a poor financial start of the year for most health systems. The graphic above shows that, after a healthier-than-expected 2021, the average hospital’s operating margin fell back into the red in early 2022, clocking in more than four percent lower than pre-pandemic levels.
Despite operational challenges, however, many of the largest health systems continue to garner headlines for their sizable profits, thanks to significant returns on their investment portfolios in 2021.
While CommonSpirit and Providence each posted negative operating margins for the second half of 2021, and Ascension managed a small operating profit, all three were able to use investment income to cushion their performance.
A growing number of health systems are doubling down on investment strategies in an effort to diversify revenue streams, and capture the kind of returns from investments generated by venture capital firms. However, it is unlikely that revenue diversification will be a sustainable long-term strategy.
To succeed, health systems must look to reconfigure elements of the legacy business model that are proving financially unsustainable amid rising expenses, shifts of care to lower-cost settings, and an evolving, consumer-centric landscape.
Thoughts of the Day: Charlie Munger
Many Americans, even those who don’t pay much attention to investing and the markets, know the name Warren Buffett.
Buffett, of course, is the billionaire philanthropist who created one of the greatest investment fortunes in history. Far fewer, however, know the name of his longtime business partner Charlie Munger.
And that’s a shame, because Munger is at least half the brains behind Berkshire Hathaway BRK.A BRK.B, the holding company he runs with Buffett and which manages billions and billions of investor dollars.
Notably, despite his deal-making prowess, Buffett is a big fan and longtime proponent of low-cost personal investing.
Munger turned 98 on Jan. 1. To celebrate his wit and market wisdom, here is a collection of quips from various interviews and question-and-answer sessions over the years.
On business education
Those of you who are about to enter business school, or who are there, I recommend you learn to do it our way. But at least until you’re out of school you have to pretend to do it their way.
On common sense
If people weren’t so often wrong, we wouldn’t be so rich.
On company earnings
Yeah, I think you would understand any presentation using the word EBITDA, if every time you saw that word you just substituted the phrase “bullsh** earnings.”
On a changing economy
So no, I’m optimistic about life. If I can be optimistic when I’m nearly dead, surely the rest of you can handle a little inflation.
On public spending
Everybody wants fiscal virtue but not quite yet. They’re like that guy who felt that way about sex. He was willing to give it up but not quite yet.
On legacy
Well, you don’t want to be like the motion picture executive in California. They said the funeral was so large because everybody wanted to make sure he was dead.
On stock buybacks
I think some people just buy it to keep the stock up. And that, of course, is insane. And immoral. But apart from that, it’s fine.
On marriage
Warren: Charlie is big on lowering expectations.
Munger: Absolutely. That’s the way I got married. My wife lowered her expectations.
On the purpose of money
Sure, there are a lot of things in life way more important than wealth. All that said…some people do get confused. I play golf with a man. He says: “What good is health? You can’t buy money with it.”
On money managers
The general system for money management requires people to pretend that they can do something that they can’t do, and to pretend to like it when they really don’t. I think that’s a terrible way to spend your life, but it’s very well paid.
On systematic investing
Well, I can’t give you a formulaic approach, because I don’t use one. If you want a formula you should go back to graduate school. They’ll give you lots of formulas that won’t work.
On human nature
As Samuel Johnson said, famously: “I can give you an argument, but I can’t give you an understanding.”
On financial innovation
It’s perfectly obvious, at least to me, that to say that derivative accounting in America is a sewer. is an insult to sewage.
On business competition
Competency is a relative concept. And what a lot of us needed to get ahead was to compete against idiots. And luckily there’s a large supply.
On cryptocurrency
I think the people who are professional traders that go into trading cryptocurrencies, it’s just disgusting. It’s like somebody else is trading turds and you decide, “I can’t be left out.”
On investment bankers
Once I asked a man who just left a large investment bank, and I said, “How does your firm make its money?” He said, “Off the top, off the bottom, off both sides, and in the middle.”
And finally, a parting shot
Munger: I think I’ve offended enough people.
Buffett: There’s two or three in the balcony!
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Rational Exuberance for Medicare Advantage Market Disrupters
Medicare Advantage (MA) focused companies, like Oak Street
Health (14x revenues), Cano Health (11x revenues), and Iora
Health (announced sale to One Medical at 7x revenues), reflect
valuation multiples that appear irrational to many market observers. Multiples may be
exuberant, but they are not necessarily irrational.
One reason for high valuations across the healthcare sector is the large pools of capital
from institutional public investors, retail investors and private equity that are seeking
returns higher than the low single digit bond yields currently available. Private equity
alone has hundreds of billions in investable funds seeking opportunities in healthcare.
As a result of this abundance of capital chasing deals, there is a premium attached to the
scarcity of available companies with proven business models and strong growth
prospects.
Valuations of companies that rely on Medicare and Medicaid reimbursement have
traditionally been discounted for the risk associated with a change in government
reimbursement policy. This “bop the mole” risk reflects the market’s assessment that
when a particular healthcare sector becomes “too profitable,” the risk increases that CMS
will adjust policy and reimbursement rates in that sector to drive down profitability.
However, there appears to be consensus among both political parties that MA is the right
policy to help manage the rise in overall Medicare costs and, thus, incentives for MA
growth can be expected to continue. This factor combined with strong demographic
growth in the overall senior population means investors apply premiums to companies in
the MA space compared to traditional providers.
Large pools of available capital, scarcity value, lower perceived sector risk and overall
growth in the senior population are all factors that drive higher valuations for the MA
disrupters. However, these factors pale in comparison the underlying economic driver
for these companies. Taking full risk for MA enrollees and dramatically reducing hospital
utilization, while improving health status, is core to their business model. These
companies target and often achieve reduced hospital utilization by 30% or more for their
assigned MA enrollees.
In 2019, the average Medicare days per 1,000 in the U.S. was 1,190. With about
$14,700 per Medicare discharge and a 4.5 ALOS, the average cost per Medicare day is
approximately $3,200. At the U.S. average 1,190 Medicare hospital days per thousand,
if MA hospital utilization is decreased by 25%, the net hospital revenue per 1,000 MA
enrollees is reduced by about $960,000. If one of the MA disrupters has, for example, 50,000 MA lives in a market, the
decrease in hospital revenues for that MA population would be about $48 million. This does not include the associated
physician fees and other costs in the care continuum. That same $48 million + in the coffers of the risk-taking MA
disrupters allows them deliver comprehensive array of supportive services including addressing social determinants of health. These services then further reduce utilization and improves overall health status, creating a virtuous circle. This is very profitable.
MA is only the beginning. When successful MA businesses expand beyond MA, and they will, disruption across the
healthcare economy will be profound and painful for the incumbents. The market is rationally exuberant about that
prospect.
How basic research leads to future job growth
A new report out later today concludes that basic scientific research plays an essential role in creating companies that later produce thousands of jobs and billions in economic value.
Why it matters: The report uses the pandemic — and especially the rapid development of new mRNA vaccines — to show how basic research funding from the government lays the necessary groundwork for economically valuable companies down the road.
By the numbers: The Science Coalition — a nonprofit group that represents 50 of the nation’s top private and public research universities — identified 53 companies that have spun off from federally funded university research.
- Those companies — which range from pharmaceutical startups to agriculture firms — have contributed more than $1.3 billion to U.S. GDP between 2015 and 2019, while supporting the creation of more than 100,000 jobs.
What they’re saying: “The COVID-19 pandemic has shown that the need for the federal government to continue investing in fundamental research is far from theoretical,” says John Latini, president of the Science Coalition. “Consistent, sustained, robust federal funding is how science evolves.”
Details: Latini praised the Biden administration’s first budget proposal to Congress, released last week, which includes what would be a $9 billion funding boost for the National Institutes of Health (NIH) — the country’s single biggest science research funding agency.
- The National Oceanic and Atmospheric Administration would see its budget rise to a record high of $6.9 billion, including $800 million reserved for climate research.
The catch: The Biden budget proposal is just that, and it will ultimately be up to Congress to decide how much to allocate to research agencies.
Context: Government research funding is vital because private money tends to go to applied research. But without basic research — the lifeblood of science — the U.S. risks missing out on potentially world-changing innovations in the future.
- The long-term value of that funding can be seen in the story of Katalin Kariko, an obscure biomedical researcher who labored for years on mRNA with little reward — until the pandemic, when her work helped provide the foundation for mRNA COVID-19 vaccines.
The bottom line: Because its ultimate payoff might lay years in the future, it’s easy to see basic research funding as a waste — until the day comes when we need it.
Are new moms really the key to health system loyalty?
https://mailchi.mp/d88637d819ee/the-weekly-gist-march-19-2021?e=d1e747d2d8
It’s long been accepted as a truism that “moms” make most of a family’s healthcare choices. This has led many health systems to invest in high-end women’s services, especially labor and delivery facilities, with the hope of winning the entire family’s long-term healthcare loyalty.
This conventional wisdom has existed since the middle of the last century, when the postwar Baby Boom coincided with the rise of commercial insurance. But it’s hard to find real evidence that these investments deliver on their intent—and we think the argument deserves to be reexamined.
An expectant mother is likely years away from her family’s major healthcare spending events. Giving her a fantastic virtual care experience, or taking great care of her teenager who blows out a knee playing soccer, is likely to engender greater loyalty to the health system when she’s looking for her first mammogram, than her labor and delivery experience from a decade earlier. That’s not to say that top-notch obstetrics isn’t important—but market-leading labor and delivery facilities are likely more critical for wholesale purchasers, such as an employer considering a narrow network, or for physicians choosing where to build an OB practice.
Direct-to-consumer strategies should be built on more sophisticated consumer research that takes into account the preferences of a new generation of consumers, for whom not all healthcare choices are equal—that same consumer will be in different “segments” and make different choices for different problems over time, not all pre-determined by one memorable birthing experience.
HENRY KOTULA 