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When Financial Performance Matters
https://www.kaufmanhall.com/insights/thoughts-ken-kaufman/when-financial-performance-matters
The Sunk Cost Fallacy
In behavioral economics, the sunk cost fallacy describes the tendency to carry on with a project or investment past the point where cold logic would suggest it is not working out. Given human nature, the existence of the sunk cost fallacy is not surprising. The more resources—time, money, emotions—we devote to an effort, the more we want it to succeed, especially when the cause is an important one.
Under normal circumstances, the sunk cost fallacy might qualify as an interesting but not especially important economic theory. But at the moment, given that 2022 will likely be the worst financial year for hospitals since 2008 and given that the hospital revenue/expense relationship seems to be entirely broken, there is little that is theoretical about the sunk cost fallacy. Instead, the sunk cost fallacy becomes one of the most important action ideas in the hospital industry’s absolutely necessary financial recovery.
Historically, cases of the sunk cost fallacy can be relatively easy to spot. However, in real time, cases can be hard to identify and even harder to act on. For hospital organizations that are subsidizing underperforming assets, identifying and acting on these cases is now essential to the financial health of most hospital enterprises.
For example, perhaps the asset that is underperforming is a hospital acquired by a health system. (Although this same concept could apply to a service line or a related service such as a skilled nursing facility, ambulatory surgery center, or imaging center.) The costs associated with integrating an acquired hospital into a health system are typically significant. And chances are, if the hospital was struggling prior to the acquisition, the purchaser made substantial capital investments to improve the performance.
As time goes on, if the financial performance of the entity in question continues to fall short, hospital executives may be reluctant to divest the asset because of their heavy investment in it.
This understandable tendency can lead the acquiring organization to throw good money after bad. After all, even when an asset is underperforming, it can’t be allowed to deteriorate. In the case of hospitals, that’s not just a matter of keeping weeds from sprouting in the parking lot. The health system often winds up supporting an underperforming hospital with both working capital and physical capital, which compounds the losses.
And the costs don’t stop there, because other assets in the system are supporting the underperforming asset. This de facto cross-subsidy has been commonplace in hospital organizations for decades. Such a cross subsidy was probably never sustainable, but it is even less so in the current challenging financial environment.
This is a transformative period in American healthcare, when hospital organizations are faced with the need to fundamentally reinvent themselves both financially and clinically. The opportunity costs of supporting assets that don’t have an appropriate return are uniquely high in such an environment. This is true whether the underperforming asset is a hospital in a smaller system, multiple hospitals in a larger system, or a service line within a hospital.
The money that is being funneled off to support underperforming assets may be better directed, for example, toward realigning the organization’s portfolio away from inpatient care and toward growth strategies. In some cases, the resources may be needed for more immediate purposes, such as improving cash flow to support mission priorities and avoiding downgrades of the organization’s credit rating.
The underlying principle is straightforward:
When a hospital supports too many low-performing assets, the capital allocation process becomes inefficient. Directing working capital and capital capacity toward assets that are dilutive to long-term financial success means that assets that are historically or potentially accretive don’t receive the resources they need to grow and thrive. The underlying principle is a clear lose-lose.
In the highly challenging current environment, it is especially important for boards and management to recognize the sunk cost fallacy and determine the right size of their hospital organizations—both clinically and financially.
Some leadership teams may determine that their organizations are too big, or too big in the wrong places, and need to be smaller in order to maximize clinical and balance-sheet strength. Other leadership teams may determine that their organizations are not large enough to compete effectively in their fast-changing markets or in a fast-changing economy.
Organizational scale is a strategy that must be carefully managed. A properly sized organization maximizes its chances of financial success in this very difficult inflationary period. Such an organization invests consistently in its best performing assets and reduces cross-subsidies to services and products that have outlived their opportunity for clinical or financial success.
Executives may see academic economic theory as arcane and not especially relevant. However, we have clearly entered a financial moment when paying attention to the sunk cost fallacy will be central to maintaining, or recovering, the financial, clinical, and mission strength of America’s hospitals.
17 health systems zeroing in on exec teams, administration in 2023
At least 17 health systems announced changes to executive ranks and administration teams in 2023.
The changes come as hospitals continue to grapple with financial challenges, leading some organizations to cut jobs and implement other operational adjustments.
The following changes were announced within the last two months and are summarized below, with links to more comprehensive coverage of the changes.
1. Middletown, N.Y.-based Garnet Health laid off 49 employees, including 25 leaders, to offset recent operating losses. The reductions represent 1.13 percent of the organization’s total workforce and $13 million in salaries and benefits.
2. Greensburg, Pa.-based Independence Health System laid off 53 employees and has cut 226 positions — including resignations, retirements and elimination of vacant positions — since January, The Butler Eagle reported June 28. The 226 reductions began at the executive level, with 13 manager positions terminated in March.
3. Coral Gables-based Baptist Health South Florida is offering its executives at the director level and above a “one-time opportunity” to apply for voluntary separation, according to a June 29 Miami Herald report. Decisions on buyout applications will be made during the summer.
4. MultiCare Health System, a 12-hospital organization based in Tacoma, Wash., will lay off 229 employees, or about 1 percent of its 23,000 staff members, including about two dozen leaders, as part of cost-cutting efforts, the health system said June 29. The layoffs primarily affect support departments, such as marketing, IT and finance.
5. Seattle Children’s is eliminating 135 leader roles, citing financial challenges. The management restructuring and reduction affects 1.5 percent of employees across the organization.
6. Bonnie Panlasigui was tapped as the first president of Summa Health System Hospitals.This new role was first announced in October as the Akron, Ohio-based system made 10 changes to its executive team: reshuffling three leaders’ roles, adding three positions and eliminating four.
7. Allentown, Pa.-based Lehigh Valley Health Network named two new regional and hospital presidents. Bob Begliomini, PharmD, was appointed president of Lehigh Valley Hospital-Cedar Crest campus in Allentown, according to a news release shared with Becker’s. He will also lead the health system’s Lehigh region, which includes four hospital campuses. Jim Miller, CRNA, was selected to replace Mr. Begliomini as president of the Muhlenberg hospital. He was also named president of the health system’s Northampton region, which includes three hospitals, Muhlenberg being one of them.
8. McLaren St. Luke’s Hospital in Maumee, Ohio, will lay off 743 workers, including 239 registered nurses, when it permanently closes this spring. Other affected roles include physical therapists, radiology technicians, respiratory therapists, pharmacists and pharmacy support staff, and nursing assistants. The hospital’s COO is also affected, and a spokesperson for McLaren Health Care told Becker’s other senior leadership roles are also affected.
9. Habersham Medical Center in Demorest, Ga., laid off four executives. The layoffs were part of cost-cutting measures before the hospital joined Gainesville-based Northeast Georgia Health System.
10. Grand Forks, N.D.-based Altru Health announced it would trim its executive team as its new hospital project moves forward. The health system is trimming its executive team from nine to six and incentivizing 34 other employees to take early retirement.
11. Scripps Health eliminated 70 administrative roles, according to WARN documents filed by the San Diego-based health system in March. The layoffs took effect May 8 and affect corporate positions in San Diego and La Jolla, Calif.
12. Columbia-based University of Missouri Health Care announced it would eliminate five hospital leadership positions across the organization. According to MU Health Care, the move is a result of restructuring “to better support patients and the future healthcare needs of Missourians.”
13. Winston-Salem, N.C.-based Novant Health laid off about 50 workers, including C-level executives, the health system confirmed to Becker’s March 29. The layoffs affected Jesse Cureton, the health system’s executive vice president and chief consumer officer since 2013; Angela Yochem, its executive vice president and chief transformation and digital officer since 2020; and Paula Dean Kranz, vice president of innovation enablement and executive director of the Novant Health Innovation Labs.
14. Philadelphia-based Penn Medicine announced that it would eliminate administrative positions. The change is part of a reorganization plan to save the health system $40 million annually, the Philadelphia Business Journal reported March 13. Kevin Mahoney, CEO of the University of Pennsylvania Health System, told Penn Medicine’s 49,000 employees changes include the elimination of a “small number of administrative positions which no longer align with our key objectives,” according to the publication.
15. Sovah Health, part of Brentwood, Tenn.-based Lifepoint Health, eliminated the COO positions at its Danville and Martinsville, Va., campuses. The responsibilities of both COO roles are now spread across members of the existing administrative team.
16. Valley Health, a six-hospital health system based in Winchester, Va., eliminated 31 administrative positions. The job cuts are part of the consolidation of the organization’s leadership team and administrative roles. They were announced internally on Feb. 28.
17. Roseville, Calif.-based Adventist Health announced it would transition from seven networks of care to five systemwide to reduce costs and strengthen operations. Under the reorganization, the health system will have separate networks for Northern California, Central California, Southern California, Oregon and Hawaii. The reorganization will result in job cuts, including reducing administration by more than $100 million.
Cartoon – Where’s your Artificial Sense of Urgency?
Thought of the Day: The 21st Century Illiterate
Thought of the Day: On Truth and Courage
Today marks the 63rd anniversary of Harper Lee‘s “To Kill a Mockingbird” (1960) — a novel containing truths so universal that they bear repeating in 2023.
“You never really understand a person until you consider things from his point of view … Until you climb inside of his skin and walk around in it.”
“I wanted you to see what real courage is … It’s when you know you’re licked before you begin but you begin anyway and you see it through no matter what. You rarely win, but sometimes you do.”
“People generally see what they look for, and hear what they listen for.”
“The one thing that doesn’t abide by majority rule is a person’s conscience.”
“Sometimes the Bible in the hand of one man is worse than a whisky bottle in the hand of another … There are just some kind of men who — who’re so busy worrying about the next world they’ve never learned to live in this one, and you can look down the street and see the results.”
Cartoon – Leadership Skills
The Five Most Important Questions Hospitals must Answer in Planning for the Future
As hospital leaders convene in Seattle this weekend for the American Hospital Association Leadership Summit, their future is uncertain.
Last week’s court decision in favor of hospitals shortchanged by the 340B drug program and 1st half 2023 improvement in operating margins notwithstanding, the deck is stacked against hospitals—some more than others. And they’re not alone: nursing homes and physician practices face the same storm clouds:
- Decreased reimbursement from government payers (Medicare and Medicaid) coupled with heightened tension with national health insurers seeking bigger discounts and direct control of hospital patient care.
- Persistent medical-inflation driving costs for facilities, supplies, wages, technologies, prescription drugs and professional services (legal, accounting, marketing, et al) higher than reimbursement increases by payers.
- Increased competition across the delivery spectrum from strategic aggregators, private equity and health insurers diversifying into outpatient, physician services et al.
- Increased discontent and burnout among doctors, nurses and care teams who feel unappreciated, underpaid and overworked.
- Escalating media criticism of not-for-profit hospitals/health system profitability, debt collection policies, lack of price transparency, consolidation, executive compensation, charity care, community benefits and more.
- Declining trust in the system across the board.
Most hospitals soldier on: they’re aware of these and responding as best they can. But most are necessarily focused only on the near-term: bed needs, workforce recruitment and staffing, procurement costs for drugs and supplies and so on. Some operate in markets less problematic than others, but the trends hold true directionally in every one of America’s 290 HRR markets.
Planning for the long-term is paralyzed by the tyranny of the urgent:
survival and sustainability in 2023 and making guarded bets about 2024 dominate today’s plans. That’s reality. Though the healthcare pie is forecast to get bigger, it’s being carved up by upstarts pursuing profitable niches and mega-players with deep pockets and a take-no-prisoners approach to their growth strategies. The result is an industry nearing meltdown.
Each traditional sector thinks it’s moral virtue more honorable than others. Each blames the other for avoidable waste and inaction in weeding out its bad actors. Each is pays lip service to “value-based care” and “system transformation” while doubling-down on making sure changes are incremental and painless for the near-term. And each believes the long-term destination of the system will be different than the past but no two agree on what that is.
Hospitals control 31% of the spend directly and as much as 43% with their employed physicians included. So, they’re a logical focus of attention from outsiders. Whether not for profit, public or investor owned, all are thought to be expensive and non-transparent and increasingly many are seen as ‘Big Business’ with excessive profits. Complaints about heavy-handed insurer reimbursement and price-gauging by drug companies fall on death ears in most communities. That’s why most are focused on near-term survival and few have the luxury or tools to plan for the future.
As a start, answers to the questions below in the 3-5 (mid-term) and 8–10-year (long-term) time frames is imperative for every hospital leadership team and Board:
- Is the status quo sustainable? With annual spending projected to increase at 5.4%/year through 2031– well above population and economic growth rates overall– will employers remain content to pay 224% of Medicare rates to produce profits for hospitals, doctors, drug and device makers and insurers? Will they continue to pass these costs through to their customers and employees while protecting their tax exemptions or will alternative strategies prompt activism? Might employers drive system transformation by addressing affordability, effectiveness, consumer self-care and systemness et al. with impunity toward discomfort created for insiders? Or, might voters reject the status quo in subsequent state/federal elections in favor of alternatives with promised improvement? And who will the winners and losers be?
- Are social determinants a core strategy or distraction? 70% of costs in the health system are directly attributable to social needs unmet—food insecurity. loneliness et al. But in most communities, programs addressing SDOH and public health programs that serve less-privileged populations are step-children to better funded hospitals and retail services targeted to populations that can afford them. Is the destination incremental bridges built between local providers and public health programs to satisfy vocal special interest groups OR comprehensive integration of SDOH in every domain of operation? Private investors are wading into SDOH if they’re attached to a risk-based insurance programs like Medicare Advantage and others, but sparingly in other settings. Does the future necessitate re-definition of “community benefits” or new regulations prompting providers, drug companies and payers to fair-share performance. Is the future modest improvement in the “Health or Human Services” status quo OR is system of “Health and Social Services” that’s fully integrated? And might interoperability and connectivity in the entire population become “true north” for tech giants and EHR juggernauts seeking to evade anti-trust constraint and demonstrate their commitment to the greater good? There’s no debate that SDOH is central to community health and wellbeing but in most communities, it’s more talk than walk. Yesterday, SDOH was about risk factors; today, it’s about low-income populations who lack insurance; tomorrow, it’s everyone.
- How should the health system of the future be funded? The current system of funding is a mess: In 2021, the federal government and households accounted for the largest shares of national health spending (34 % and 27%, respectively), followed by private businesses (17%), state and local governments (15%), and other private revenues (7%). It will spend $4.66 trillion, employ 19 million and impact every citizen (and non-citizen) directly. But 4 of 10 households have unpaid medical bills. Big employers in certain industries provide rich benefits while half of small businesses provide none. Medicare depends on employer payroll taxes for the lion’s share of its Part A (Hospital) funding exposing the “trust fund” to a shortfall in 2028 and insolvency fears…and so on. Increased public funding via taxes is problematic and debt is more costly as interest rates go up and the municipal bond market tightens. Voters and private employers don’t seem inclined to pay higher taxes for healthcare–:is it worth $13,998 per capita today? $20,426 in 2031? Will high-cost inpatient care and specialty drugs become regulated public utilities in which access and pricing is tightly controlled and directly funded by government? Will private investors and strategic aggregators be required to take invest in community benefits to offset the disproportionate costs borne by hospitals, public health clinics and others? Is there a better formula for funding U.S. healthcare? Other systems of the world spend more on social services and preventive health and less on specialty care. They spend a third less and get comparable if not better outcomes though each is stretched to deal with medical inflation. And in most, government funding is higher, private funding lower and privileged populations have access to private services they pay for directly. Where do we start, and who demands the question be answered?
- How will innovations in therapeutics and information technology change how individuals engage with the system? Artificial intelligence will directly impact 60% of the traditional health delivery workforce, negating jobs for many/most. Non-allopathic therapies, technology-enabled self-care, precision medicines, non-invasive and minimally invasive surgical techniques are changing change how care is delivered, by whom and where. Thus, lag indicators based on visits, procedures, admissions and volume are increasingly useless. How will demand be defined in the future? Who will own the data and how will it be accessed? And how will the rights of patients (consumers) be protected in courts and in communities? In the future, information-driven healthcare will be much more than encounter data from medical records and claims-based analyses from payers. It will be sourced globally, housed centrally and accessed by innovators and consumers to know more about their health now and next. Within 10 years, generative AI coupled with therapeutic innovation will fundamentally change roles, payments and performance measurement in every domain of healthcare. Proficiency in leveraging the two will anchor system reputations and facilitate significant market share shifts to high value, high outcome, lower cost alternatives…whether local or not.
- How will regulators and court decisions enact fair competition, consumer choices and antitrust protections? The current political environment is united around reforms that encourage price transparency and affordability. FTC and DOJ leaders are aligned on healthcare oversight with a decided bent toward heightened enforcement and tighter scrutiny of proposed deals (both vertical and horizontal integration). But their leaders’ terms are subject to political appointments and elections: that’s an unknown. And while recent rulings of the conservative leaning Supreme Court are problematic to many in healthcare, their rulings are perhaps more predictable than policies, rules and regulations directly impacted by election results.
For hospital leaders gathering in Seattle this week, and in local board meetings nationwide, necessary attention is being given the near-term issues all face. But longer-term issues lurk: the future does not appear a modernized version of the past for anyone in U.S. healthcare, especially hospitals. And among hospitals, fundamental precepts—like tax exemptions for “not-for-profit” hospitals, community benefits and charity care in exchange for tax exemption, EMTALA et al. regulations that require access without pre-condition are among many that will re-surface as the long-term view of the health system is re-considered.
To that end, the questions above deserve urgent discussion in every hospital board room and C suite. Trade-offs aren’t clear, potential future state hospital scenarios are not discreet and winners and losers unknown. But a fact-driven process recognizing a widening array of players with deep pockets and fresh approaches is necessary.
Thought of the Day: On Walking vs Talking
HENRY KOTULA 