As everyone in our industry knows, sluggish volumes amid persistently rising costs, especially for labor, have sent health system margins into a downward spiral across 2022. Using the latest data from consultancy Kaufman Hall, the graphic above shows that by the end of this year, employed labor expenses will have increased more than all non-labor costs combined.
While contract labor usage, namely travel nursing, is declining, the constant battle for nursing talent means travel nurses are still a significant expense at many hospitals. Through the first six months of this year, over half of hospitals reported a negative operating margin, and the median hospital operating margin has dropped over 100 percent from 2019.
Larger health systems are not faring better: all five of the large, multi-regional, not-for-profit systems we’ve highlighted below saw their operating margins tumble this year, with drops ranging from three points (Kaiser Permanente) to nearly seven points (CommonSpirit Health and Providence).
While these unfavorable cost trends have been building throughout COVID, health systems now have neither federal relief nor returns from a thriving stock market to help stabilize their deteriorating financial outlooks.
Health system boards will tolerate negative margins in the short-term (especially given that many have months’ worth of days cash on hand), but if this situation persists into 2023, pressure for service cuts, layoffs, and restructuring will mount quickly.
Moody’s Investors Service has downgraded MultiCare Health System’s revenue bonds to “A1” from “Aa3,” and revised the health system’s rating outlook to negative from stable.
Moody’s said the downgrade and the revision of the outlook to negative reflect several pressures that weaken the health system’s credit profile, including an unexpected 24 percent increase in debt, a decline in liquidity and significant operating losses through the first six months of fiscal 2022.
“Operations are expected to improve through the second half of fiscal 2022, but nevertheless full year results will remain weak, providing at best thin headroom to MultiCare’s debt service coverage covenant,” Moody’s said.
Moody’s noted that MultiCare, an 11-hospital system based in Tacoma, Wash., will continue to benefit from several strengths, including a large and growing revenue base and strong clinical offerings.
Mayo Clinic’s revenue and expenses were higher in the second quarter of this year, according to financial documents released Aug. 18.
Rochester, Minn.-based Mayo Clinic’s revenue totaled $4.03 billion in the second quarter of this year, up from $3.94 billion in the same period a year earlier.
The nonprofit health system’s expenses climbed 11 percent year over year to $3.88 billion in the second quarter of 2022. Mayo Clinic saw expenses increase across all categories, including salaries and benefits.
Mayo Clinic ended the second quarter of this year with operating income of $155 million, down 66 percent from $451 million in the same quarter of 2021.
Mayo Clinic has major campuses in Rochester, Jacksonville, Fla., and Scottsdale and Phoenix, Ariz.
Kaiser Permanente reported lower revenues in the second quarter of this year than in the same period a year earlier, and the Oakland, Calif.-based healthcare giant ended the period with a net loss.
Kaiser, which provides healthcare and health plans, reported operating revenue of $23.47 billion in the second quarter of 2022, down from $23.69 billion in the same quarter of 2021. The organization’s expenses climbed from $23.34 billion in the second quarter of last year to $23.38 billion in the same period this year.
“Much like the entire health care industry, we continue to address deferred care while navigating COVID-19 surges and associated expenses,” Kathy Lancaster, Kaiser executive vice president and CFO, said in an Aug. 5 earnings release. “Kaiser Permanente’s integrated model of providing both care and coverage enables us to meet these challenges as demonstrated by our moderate increase in year-over-year operating expenses for the second quarter.”
Kaiser ended the second quarter of this year with operating income of $89 million, down from $349 million a year earlier.
After factoring in a nonoperating loss of $1.4 billion, Kaiser reported a net loss of $1.3 billion for the second quarter of this year, compared to net income of $2.97 billion in the same period last year. Kaiser said the loss was largely attributable to market conditions.
This is the second quarter in a row that Kaiser has reported a loss. The organization closed out the first quarter of this year with a net loss of $961 million, compared to net income of $2 billion in the same quarter of 2021.
Updated on Aug. 5 with comments from Sutter Health.
A $457 million net loss for the quarter ended June 30 has brought Sutter Health even deeper into the red for 2022, according to new financial filings.
The Sacramento-based nonprofit health system brought in $3.49 billion in total operating revenues from the quarter, down slightly from the prior year’s $3.51 billion.
At the same time, the system’s operating expenses grew from $3.41 billion in the second quarter of 2021 to $3.55 billion in the most recent quarter, driven by $30 million and $151 million year-over-year increases in salaries and purchased services, respectively. The latter includes the increased professional fees being felt by labor-strapped systems across the country.
These led the system to report a $51 million operating loss for the quarter as opposed to the $106 million operating gain from last year’s equivalent quarter.
“Poorly” performing financial markets also took a toll on Sutter’s numbers. The system’s quarterly investment income dipped from $251 million to $56 million from 2021 to 2022. A $495 million downward change in net unrealized gains and losses on its investments was also a stark reversal from the prior year’s $270 million increase.
Despite a 1.5% year-over-year operating revenue increase to $7.05 billion for the opening six months, a 1.7% year-over-year operating revenue bump places the system’s year-to-date income at $44 million (0.6% operating margin), slightly below last year’s $57 million (0.8% operating margin).
However, market struggles through both quarters and a $208 million loss tied to the disaffiliation of Samuel Merritt University now has Sutter sitting at a $641 million net loss for the opening half of 2022. The system was up $825 million at the same time last year.
“Sutter’s finances have stabilized, but our year-to-date numbers show we still have more affordability work ahead as we strive to best position Sutter Health to serve our patients and communities into the future,” the system wrote in an email statement. “We are grateful for our employees and clinicians who have worked diligently over the last several years to help bring our costs down—at the same time managing through the pandemic and continuing to provide high-quality, nationally recognized care.”
Sutter noted in the filing that it is or will be in labor negotiations with much of its unionized workforce, as 43% of its contract agreements have either expired or will be running their course within the year.
The filing also included notice of a handful of legal matters that have yet to be resolved. These include an antitrust verdict in favor of Sutter that is being appealed by the plaintiff, a lawsuit regarding an alleged privacy breach of two anonymous plaintiffs and two separate class-action complaints regarding employee retirement plan funding, among others.
“The organization continues to face financial headwinds like inflation and increased staffing costs, as evidenced by our near breakeven operating margin,” Sutter said in a statement. “Even still, we are encouraged that independent ratings agencies have recently acknowledged our efforts to date. In the second quarter, Moody’s, S&P and Fitch all affirmed the system’s existing ‘A’ category bond ratings.”
Much of Sutter’s pains are being felt across the industry. A recent Kaufman Hall industrywide report showed only marginal relief from expenses and middling non-COVID volume recovery through June, while a Fitch Ratings update on nonprofit hospitals warned that these challenges and broader inflation pressures will likely weigh down the sector through 2022.
Hospitals are forced to absorb inflationary expenses, particularly related to supporting their workforce, AHA says.
The Centers for Medicare and Medicaid Services’ increase in the inpatient payment rate for 2023 is welcome but not enough to offset expenses, according to the American Hospital Association.
CMS set a 4.1% market basket update for 2023 in its final rule released Monday, calling it the highest in the last 25 years. The increase was due to the higher cost in compensation for hospital workers.
The final rule gave inpatient hospitals a 4.3% increase for 2023, as opposed to the 3.2% increase in April’s proposed rule.
WHY THIS MATTERS
CMS used more recent data to calculate the market basket and disproportionate share hospital payments, a move that better reflects inflation and labor and supply cost pressures on hospitals, the AHA said.
“That said, this update still falls short of what hospitals and health systems need to continue to overcome the many challenges that threaten their ability to care for patients and provide essential services for their communities,” said AHA Executive Vice President Stacey Hughes. “This includes the extraordinary inflationary expenses in the cost of caring hospitals are being forced to absorb, particularly related to supporting their workforce while experiencing severe staff shortages.”
The AHA would continue to urge Congress to take action to support the hospital field, including by extending the low-volume adjustment and Medicare-dependent hospital programs, Hughes said.
In late July, Senate and House members urged CMS to increase the inpatient hospital payment.
Premier, which works with hospitals, also said the 4.3% payment update falls short of reflecting the rising labor costs that hospitals have experienced since the onset of the pandemic.
“Coupled with record high inflation, this inadequate payment bump will only exacerbate the intense financial pressure on American hospitals,” said Soumi Saha, senior vice president of Government Affairs for Premier.
THE LARGER TREND
Recent studies show hospitals remain financially challenged since the COVID-19 pandemic’s effect on revenue and supply chain and labor expenses. Piled onto that has been inflation that has added to soaring expenses.
Hospital margins were up slightly from May to June, but are still significantly lower than pre-pandemic levels, according to a Flash Report from Kaufman Hall.
The effects of the pandemic on the healthcare industry have been profound, resulting in the creation of new business models, according to a report from McKinsey.
Transformational change is necessary as hospitals have been hit hard by eroding margins due to cost inflation and expenses, Fitch found.
Expenses are still weighing heavily on hospitals, health systems, and physician’s practices as the cost of care continues to rise.
Hospitals, health systems, and physician’s practices are still struggling under the weight of significant financial pressure, that the rise in patient volume and revenue can’t seem to outweigh.
The increase in patient volume and revenue has not been able to offset the historically high operating margins these organizations are facing, according to data from Kaufman Hall’s National Hospital Flash Report and Physician Flash Report. Hospitals, health systems, and physician’s practices dealt with negative margins in June for the sixth consecutive month this year.
“To say that 2022 has challenged healthcare providers is an understatement,” Erik Swanson, a senior vice president of data and analytics with Kaufman Hall, said in an email report. “It’s unlikely that hospitals and health systems can undo the damage caused by the COVID-19 waves of earlier this year, especially with material and labor costs at record highs this summer.”
The median Kaufman Hall year-to-date operating margin index for hospitals was -0.09% through June, for the sixth month of cumulative negative actual operating margins. However, the median change in operating margin in June was up 30.8% compared to May, but down 49.3% from June 2021.
Hospital revenues for June continued to trend upward, even as volumes evened out, according to the Kauffman Hall data. Organizations saw a 2.1% drop in patient length of stay. Both patient days and emergency department visits each dropped by 2.6% in June when compared to May. Hospital’s gross operating revenue was up 1.2% in June from May.
Expenses have been dragging down hospital margins for months, however, June saw a slight month-over-month improvement as total hospital expenses dropped 1.3%, despite this, year-over-year expenses are still up 7.5% from June 2021. Physician practices saw a drop in provider compensation, according to the Kaufman Hall data, however, this wasn’t enough to offset expenses. The competitive labor market for healthcare support staff resulted in a new high for total direct expense per provider FTE in Q2 2022 of $619,682—up 7% from the second quarter of 2021 and 12% from the second quarter of 2020.
“Given the trends in the data, physician practices need to focus on efficiency in the second half of 2022,” Matthew Bates, managing director and Physician Enterprise service line lead with Kaufman Hall, said in the email report. “Amid historically high expenses, shifting some services away from physicians to advanced practice providers like nurse practitioners or physician assistants could help rein in the costs of treating an increased patient load while taking some of the weight off the shoulders of physicians.”
While for-profit health system giants HCA Healthcare and Tenet Healthcare reported reductions in contract labor usage last quarter, sustained higher labor costs and sluggish demand resulted in both of them, along with Community Health Systems and Universal Health Services, seeing their net income decline in the second quarter.
Like many systems, the for-profit chains seem to have successfully weaned themselves from earlier reliance on expensive temporary nurses, but are facing more structural increases in labor costs as salaries have risen to remain competitive in a very tight labor market.
The Gist: The earnings reports from for-profit companies are a canary in the coal mine for the overall margin performance of the industry. Although investor-owned companies are vastly outnumbered by their not-for-profit peers, they often move more quickly, and with more vigor, to reduce costs in order to meet the earnings expectations of Wall Street investors. They also typically rely more heavily on volume growth—particularly emergency department visits—as a driver of earnings.
If for-profits are now finding it more difficult to pull those levers, we’d expect that the broader universe of nonprofit systems is experiencing even tougher sledding. That’s consistent with what we’re hearing anecdotally from health systems we work with.
HENRY KOTULA 