Category Archives: Operating Margin

Healthcare Spending 2000-2022: Key Trends, Five Important Questions

Posted on by • Posted in Affordability, Aging Population, Dept of Justice (DOJ), Health Plan, Health Policy, Health System, Healthcare Reform, Healthcare Sector, Inflation Reduction Act, Market Consolidation, Market Trends, Medicare, Medicare Funding, Monopoly Behavior, Operating Margin, Operating Margin Drivers, Out of Pocket Expenses, Underinsured, Uninsured, UnitedHealth Group, UnitedHealthcare • Leave a comment
Healthcare Spending 2000-2022: Key Trends, Five Important Questions

Last week, Congress avoided a partial federal shutdown by passing a stop-gap spending bill and now faces March 8 and March 22 deadlines for authorizations including key healthcare programs.

This week, lawmakers’ political antenna will be directed at Super Tuesday GOP Presidential Primary results which prognosticators predict sets the stage for the Biden-Trump re-match in November. And President Biden will deliver his 3rd State of the Union Address Thursday in which he is certain to tout the economy’s post-pandemic strength and recovery.

The common denominator of these activities in Congress is their short-term focus: a longer-term view about the direction of the country, its priorities and its funding is not on its radar anytime soon. 

The healthcare system, which is nation’s biggest employer and 17.3% of its GDP, suffers from neglect as a result of chronic near-sightedness by its elected officials. A retrospective about its funding should prompt Congress to prepare otherwise.

U.S. Healthcare Spending 2000-2022

Year-over-year changes in U.S. healthcare spending reflect shifting demand for services and their underlying costs, changes in the healthiness of the population and the regulatory framework in which the U.S. health system operates to receive payments. Fluctuations are apparent year-to-year, but a multiyear retrospective on health spending is necessary to a longer-term view of its future.

The period from 2000 to 2022 (the last year for which U.S. spending data is available) spans two economic downturns (2008–2010 and 2020–2021); four presidencies; shifts in the composition of Congress, the Supreme Court, state legislatures and governors’ offices; and the passage of two major healthcare laws (the Medicare Modernization Act of 2003 and the Affordable Care Act of 2010).

During this span of time, there were notable changes in healthcare spending:

  • In 2000, national health expenditures were $1.4 trillion (13.3% of gross domestic product); in 2022, they were $4.5 trillion (17.3% of the GDP)—a 4.1% increase overall, a 321% increase in nominal spending and a 30% increase in the relative percentage of the nation’s GDP devoted to healthcare. No other sector in the economy has increased as much.
  • In the same period, the population increased 17% from 282 million to 333 million, per capita healthcare spending increased 178% from $4,845 to $13,493 due primarily to inflation-impacted higher unit costs for , facilities, technologies and specialty provider costs and increased utilization by consumers due to escalating chronic diseases.
  • There were notable changes where dollars were spent: Hospitals remained relatively unchanged (from $415 billion/30.4% of total spending to $1.355 trillion/31.4%), physician services shrank (from $288.2 billion/21.1% to $884.8/19.6%) and prescription drugs were unchanged (from $122.3 billion/8.95% to $405.9 billion/9.0%).
  • And significant changes in funding Out-of-pocket shrank from 14.2% ($193.6 billion in 2020) to (10.5% ($471 billion) in 2020, private insurance shrank from $441 billion/32.3% to $1.289 trillion/29%, Medicare spending grew from $224.8 billion/16.5% to $944.3billion/21%; Medicaid and the Children’s Health Insurance Program spending grew from $203.4 billion/14.9% to $7805.7billion/18%; and Department of Veterans Affairs healthcare spending grew from $19.1 billion/1.4% to $98 billion/2.2%.

Looking ahead (2022-2031), CMS forecasts average National Health Expenditures (NHE) will grow at 5.4% per year outpacing average GDP growth (4.6%) and resulting in an increase in the health spending share of Gross Domestic Product (GDP) from 17.3% in 2021 to 19.6% in 2031.

The agency’s actuaries assume

“The insured share of the population is projected to reach a historic high of 92.3% in 2022… Medicaid enrollment will decline from its 2022 peak of 90.4M to 81.1M by 2025 as states disenroll beneficiaries no longer eligible for coverage. By 2031, the insured share of the population is projected to be 90.5 percent. The Inflation Reduction Act (IRA) is projected to result in lower out-of-pocket spending on prescription drugs for 2024 and beyond as Medicare beneficiaries incur savings associated with several provisions from the legislation including the $2,000 annual out-of-pocket spending cap and lower gross prices resulting from negotiations with manufacturers.”

My take:

The reality is this: no one knows for sure what the U.S. health economy will be in 2025 much less 2035 and beyond. There are too many moving parts, too much invested capital seeking near-term profits, too many compensation packages tied to near-term profits, too many unknowns like the impact of artificial intelligence and court decisions about consolidation and too much political risk for state and federal politicians to change anything.

One trend stands out in the data from 2000-2022: The healthcare economy is increasingly dependent on indirect funding by taxpayers and less dependent on direct payments by users. 

In the last 22 years, local, state and federal government programs like Medicare, Medicaid and others have become the major sources of funding to the system while direct payments by consumers and employers, vis-à-vis premium out-of-pocket costs, increased nominally but not at the same rate as government programs. And total spending has increased more than the overall economy (GDP), household wages and  costs of living almost every year.

Thus, given the trends, five questions must be addressed in the context of the system’s long-term solvency and effectiveness looking to 2031 and beyond:

  • Should its total spending and public funding be capped?
  • Should the allocation of funds be better adapted to innovations in technology and clinical evidence?
  • Should the financing and delivery of health services be integrated to enhance the effectiveness and efficiency of the system?
  • Should its structure be a dual public-private system akin to public-private designations in education?
  • Should consumers play a more direct role in its oversight and funding?

Answers will not be forthcoming in Campaign 2024 despite the growing significance of healthcare in the minds of voters. But they require attention now despite political neglect.

PS: The month of February might be remembered as the month two stalwarts in the industry faced troubles:

United HealthGroup, the biggest health insurer, saw fallout from a cyberattack against its recently acquired (2/22) insurance transaction processor by ALPHV/Blackcat, creating havoc for the 6000 hospitals, 1 million physicians, and 39,000 pharmacies seeking payments and/or authorizations. Then, news circulated about the DOJ’s investigation about its anti-competitive behavior with respect to the 90,000 physicians it employs. Its stock price ended the week at 489.53, down from 507.14 February 1.

And HCA, the biggest hospital operator, faced continued fallout from lawsuits for its handling of Mission Health (Asheville) where last Tuesday, a North Carolina federal court refused to dismiss a lawsuit accusing it of scheming to restrict competition and artificially drive-up costs for health plans. closed at 311.59 last week, down from 314.66 February 1.

UPMC back in the red with $198M operating loss, -0.7% margin

Posted on by • Posted in Financial Performance, Health Plan, Health System, Integrated Delivery System, Net Income, Nonoperating Income, Operating Income, Operating Margin, Operating Margin Drivers, University of Pittsburgh Medical Center (UPMC) • Leave a comment
https://www.beckershospitalreview.com/finance/upmc-back-in-the-red-with-198m-operating-loss-0-7-margin.html?origin=CFOE&utm_source=CFOE&utm_medium=email&utm_content=newsletter&oly_enc_id=2893H2397267F7G

Pittsburgh-based UPMC reported a $198 million operating loss (-0.7% margin) in 2023, down from a $162 million gain (0.6% margin) in 2022, according to financial documents published Feb. 28.

UPMC attributed the swing from operating income to loss to various factors, including increased labor and supply costs, increases in medical claims expense due to higher utilization and certain legal settlements. 

Revenue for the health system increased 8.5% year over year to $27.7 billion and expenses rose 10% to $27.9 billion. Under expenses, labor costs increased 6.4% to $9.7 billion and supply costs were up 11% to $7.4 billion.

After accounting for nonoperating items, such as investment returns, UPMC ended 2023 with a $31 million net loss, compared to a $1 billion net loss the previous year. 

As of Dec. 31, UPMC had more than $9.5 billion in cash and investments, $3.2 billion of which was held by its regulated health and captive insurance companies.

The Numbers Behind the Numbers

Posted on by • Posted in Average Length of Stay (ALOS), Contract Labor, Health System, Hospital, Hospital Industry, Key Performance Indicators, Operating Income, Operating Margin, Operating Margin Drivers, Operating Metrics, Operating Performance, Outpatient Care, Outpatient Migration, Outpatient Revenue • Leave a comment

https://www.kaufmanhall.com/insights/thoughts-ken-kaufman/numbers-behind-national-hospital-flash-report

U.S. Hospital YTD Operating Margin Index November 2021-December 2023

The observations and questions from this chart are both interesting and required reading for hospital executives:

  • Why were hospitals profitable at the 4% plus level through the worst of the 2021 Covid period?
  • What exactly happened between December of 2021 and January of 2022 that resulted in a profitability decrease from a positive 4.2% to a negative 3.4%?
  • Despite the best efforts of hospital executives, overall operating margins were negative throughout calendar year 2022 and did not return to positive territory until March of 2023.
  • Hospital margins remained positive throughout 2023 and into 2024. However, overall margins have remained below those experienced in both 2021 and in the pre-Covid year of 2019.

The above questions and observations have proven interesting, and the ongoing numbers have proven quite useful in many quarters of healthcare. But recently I was talking with Erik Swanson, who is the leader of the Kaufman Hall Flash Report and our executive behind the data, numbers, and statistics. Erik and I were speculating about all of the above observations, but our key speculation was whether the 2023 operating margin results actually reflected a hospital financial turnaround or, in fact, were there “numbers behind the numbers” that told a different and much more nuanced story. So Erik and I asked different questions and took a much deeper dive into the Flash Report numbers. The results of that dive were quite telling:

  1. Too many hospitals are still losing money. Despite the fact that the Operating Margin Index median for 2023 and into 2024 was over 2%, when you look harder at the Flash Report data, you find that 40% of American hospitals continue to lose money from operations into 2024.
  2. There is a group of hospitals that have substantially recovered financially. Interestingly, the data shows over time that the high-performing hospitals in the country are doing better and better. They are effectively pulling away from the pack.
  3. This leads to the key question: Why are high-performing hospitals doing better? It turns out that several key strategic and managerial moves are responsible for high-performing hospitals’ better and growing operating profitability:
    • Outpatient revenue. Hospitals with higher and accelerating outpatient revenue were, in general, more profitable.
    • Contract labor. Hospitals that have lowered their percentage of contract labor most quickly are now showing better operating profitability.
    • An important managerial fact. The Flash Report found that hospitals with aggressive reductions in contract labor were also correlated to rising wage rates for full-time employees. In other words, rising wage rates have appeared to attract and retain full-time staff which, in turn, has allowed those hospitals to reduce contract labor more quickly, all of which has led to higher profitability.
    • Average length of stay. No surprise here. A lower average length of stay is correlated to improved profitability. Those hospitals that have hyper-focused on patient throughput, which has led to appropriate and prompt patient discharge, have also proven this to be a positive financial strategy.
  4. Lower financial performers have financially stagnated throughout the pandemic. The data shows that throughout the pandemic, hospitals with good financial results improved those results, but of more consequence, hospitals with poor financial performance saw that performance worsen. The Flash Report documents that the poorest financially performing hospitals currently show negative operating margins ranging from negative 4% to negative 19%. Continuation of this level of financial performance is not only unstainable but also makes crucial re-investment in community healthcare impossible.
  5. The urban hospital/rural hospital myth. A popular and often quoted hospital comparison is that there is an observable financial divide between urban and rural hospitals. Erik Swanson and I found that recent data does not support this common perception. When you compare “all rurals” to “all urbans” on the basis of average operating margin, no statistically significant difference emerges. However, what does emerge—and is a very important statistical observation—is that the lowest performing 20% of rural hospitals are, in fact, generating much lower margins then their urban counterparts this year. It is at this lowest level of rural hospital performance where the real damage is being done. 
  6. Rural hospitals and obstetrics. The data does confirm one very important American healthcare issue: Obstetrics and delivery services are one of the leading money losers of all hospital service offerings. And the data further confirms that rural hospitals are closing obstetric departments with more frequency in order to protect the financial viability of the overall rural hospital enterprise. This is a health policy issue of major and growing consequence.

The point here is that data, numbers, and statistics matter both to setting long-term social health policy agendas and to the strategic management of complex provider organizations. But the other point is that the quality and depth of the analysis is an equally important part of the process. A first glance at the numbers may suggest one set of outcomes. However, a deeper, more careful and penetrating analysis may reveal critical quantitative conclusions that are much more telling and sophisticated and can accurately guide first-class organizational decision-making. Hopefully the analytics here are a good example of this very point.

Walgreens’ VillageMD exits the Florida market

Posted on by • Posted in Cost Reduction, Disruption, Innovation, Investor Expectations, Operating Margin, Operating Metrics, Operating Performance, Patience, Primary Care, Private Equity, Walgreens, Walk-in Clinics • Leave a comment

https://mailchi.mp/f9bf1e547241/gist-weekly-february-23-2024?e=d1e747d2d8

Walgreens announced this week that it will be shutting down all of its Florida-based VillageMD primary care clinics. Fourteen clinics in the Sunshine State have already closed, with the remaining 38 expected to follow by March 15.

This move comes in the wake of a $1B cost-cutting initiative announced by Walgreens executives last fall, which included plans to shutter at least 60 VillageMD clinics across five markets in 2024.

Last month VillageMD exited the Indiana market, where it was operating a dozen clinics.

Despite downsizing its primary-care footprint, Walgreens says it remains committed to its expansion into the healthcare delivery sector, having invested $5.2B in VillageMD in 2021 and purchased Summit Health-CityMD for $9B through VillageMD in 2023. 

The Gist: Having made significant investments in provider assets, Walgreens now faces the difficult task of creating an integrated and sustainable healthcare delivery model, which takes time. 

Unlike long-established healthcare providers who feel more loyal to serving their local communities, nontraditional healthcare providers like Walgreens can more easily pick and choose markets based on profitability.

While this move is disruptive to VillageMD patients in Florida and the other markets it’s exiting, Walgreens seems to be answering to its investors, who have been dissatisfied with its recent earnings.

Financial distress increasingly prevalent in health system M&A deals

Posted on by • Posted in Financial Stewardship, Financial Viability, Financially Distressed, Health System, Hospital, Hospital Industry, Market Consolidation, Market Trends, Mergers & Acquisitions, Operating Margin, Operating Margin Drivers, Operating Performance • Leave a comment

https://mailchi.mp/1e28b32fc32e/gist-weekly-february-9-2024?e=d1e747d2d8

This week’s graphic highlights data from Kaufman Hall’s recently released 2023 Hospital and Health System M&A Report on the current dynamics in health system mergers and acquisitions (M&A) activity.

After a slowdown during the pandemic, 2023 saw an uptick in M&A activity with 65 announced transactions, the most since 2020. Continuing the trend of the past two years, the number of announced “mega mergers,” in which the smaller party had at least $1B in annual revenue, represented more than a tenth of total announced transactions. 

However, the average size of mergers fell in 2023, as financial distress emerged as a key driver of M&A activity. The percent of mergers involving a financially distressed party spiked to nearly 28 percent in 2023, almost double the level seen in prior years. 

CARES Act funding had buoyed some health systems’ balance sheets through the pandemic, but with the end of federal aid, more systems needed to seek shelter through scale. 

With the median hospital operating margin still barely hitting two percent, we anticipate this heightened level M&A activity to continue in 2024 as health systems search for stronger partners that can help them stabilize financially. 

Fitch says lower operating margins may be the new normal for nonprofit hospitals

Posted on by • Posted in Credit Downgrade, Credit Quality, Credit Ratings, Debt Capacity, Debt Levels, Debt Service, Debt Service Coverage Ratio, Financial Reserves, Financial Stewardship, Financial Strength, Financial Viability, Financially Distressed, Health System, Hospital, Hospital Industry, Operating Expenses, Operating Income, Operating Margin, Operating Margin Drivers, Operating Performance, Operating Revenue, Outpatient Migration, Strategic Imperative • Leave a comment

https://mailchi.mp/09f9563acfcf/gist-weekly-february-2-2024?e=d1e747d2d8

On Monday, Fitch Ratings, the New York City-based credit rating agency, released a report predicting that the US not-for-profit hospital sector will see average operating margins reset in the one-to-two percent range, rather than returning to historical levels of above three percent. 

Following disruptions from the pandemic that saw utilization drop and operating costs rise, hospitals have seen a slower-than-expected recovery.

But, according to Fitch, these rebased margins are unlikely to lead to widespread credit downgrades as most hospitals still carry robust balance sheets and have curtailed capital spending in response. 

The Gist: As labor costs stabilize and volumes return, the median hospital has been able to maintain a positive operating margin for the past ten months. 

But nonprofit hospitals are in a transitory period, one with both continued challenges—including labor costs that rebased at a higher rate and ongoing capital restraints—and opportunities—including the increase in outpatient demand, which has driven hospital outpatient revenue up over 40 percent from 2020 levels.

While the future margin outlook for individual hospitals will depend on factors that vary greatly across markets, organizations that thrive in this new era will be the ones willing to pivot, take risks, and invest heavily in outpatient services.

Three Must-Haves for Every Rating Presentation

Posted on by • Posted in Board, Bond Default Risk, Bond Rating, Bond Rating Agency, CFO, Credit Quality, Credit Rating Committee, Credit Rating Process, Credit Ratings, Debt Capacity, Debt Covenant Default, Debt Default, Debt Issuance, Debt Levels, Debt Service Covenants, Debt Service Coverage Ratio, Health System, Hospital, Hospital Industry, Key Credit Metrics, Key Metrics, Key Performance Indicators, Key Ratios, Leverage, Non-Recurring Revenue or Expenses, Operating Expenses, Operating Income, Operating Margin, Operating Margin Drivers, Operating Metrics, Operating Performance, Operating Revenue • Leave a comment
https://www.kaufmanhall.com/insights/blog/three-must-haves-every-rating-presentation?utm_source=mkto&utm_campaign=lisa-blog&utm_medium=em&utm_term=240213&mkt_tok=NjU0LUNOWS0yMjQAAAGRQfSwr9Ko8xY6xvplhP7oPiD8w2ozAvGxvApt5QPNxC39ZC_Wh1AETTXmy-uVnpveuYHzTdZfqDA7hLAOqMLHgwjovy2d0UA1ZrKhjC70Odi5

Creating a great rating agency presentation is imperative to telling your story. I’ve probably seen a thousand presentations across the past three decades and I can say without a doubt that a great presentation will find its way into the rating committee. Show me a crisp, detailed, well-organized presentation, and I’ll show you a ratings analyst who walks away with high confidence that the management team can navigate the industry challenges ahead.

During the pandemic, Kaufman Hall recommended that hospitals move financial performance to the top of the presentation agenda. Better presentations chronicled the immediate, “line item by line item” steps management was taking to stop the financial bleeding and access liquidity. We still recommend this level of detail in your presentations, but as many hospitals relocate their bottom line, management teams are now returning to discussing longer-term strategy and financial performance in their presentations.

Beyond the facts and figures, many hospitals ask me what the rating analysts REALLY want to know. Over those one thousand presentations I’ve seen, the presentations that stood out the most addressed the three themes below:

  1. What makes your organization essential? Hospitals maintain limited price elasticity as Medicare and Medicaid typically comprise at least half of patient service revenue, leaving only a small commercial slice to subsidize operations. The ability to negotiate meaningful rate increases with payers will largely rest on the ability to prove why the hospital is a “must-have” in the network. In other words, a health plan that can’t sell a product without a hospital in its network is the definition of essential. This conversation now also includes Medicare Advantage plans as penetration rates increase rapidly across the country. Essentiality may be demonstrated by distinct services, strong clinical outcomes and robust medical staff, multiple access points across a certain geography, or data that show the hospital is a low-cost alternative compared to other providers. Volume trends, revenue growth, and market share show that essentiality. A discussion on essentiality is particularly needed for independent providers who operate in crowded markets.
  2. What makes your financial performance durable? Many hospitals are showing a return to better performance in recent quarters. Showing how your organization will sustain better financial results is important. Analysts will want to know what the new “run rate” is and why it is durable. What are the undergirding factors that make the better margins sustainable? Drivers may include negotiated rate increases from commercial payers and revenue cycle improvements. On the expense side, a well-chronicled plan to achieve operating efficiencies should receive material airtime in the presentation, particularly regarding labor. It is universally understood that high labor costs are a permanent, structural challenge for hospitals, so any effort to bend the labor cost curve will be well received. Management should also isolate non-recurring revenue or expenses that may drive results, such as FEMA funds or 340B settlements. To that end, many states have established new direct-to-provider payment programs which may be meaningful for hospitals. Expect questions on whether these funds are subject to annual approval by the state or CMS. The analysts will take a sharpened pencil to a growing reliance on these funds. 

    The durability of financial performance should be represented with highly detailed multi-year projections complete with computed margin, debt, and liquidity ratios. Know that analysts will create their own conservative projections if these are not provided, which effectively limits your voice in the rating committee. 

    We also recommend that hospitals include a catalogue of MTI and bank covenants in the presentation. Complying with covenants are part of the agreement that hospitals make with their lenders, and it is the organization’s responsibility to report how it’s performing against these covenants. General philosophy on headroom to covenants also provides insight to management’s operating philosophy. For example, is it the organization’s goal to have narrow, adequate, or ample headroom to the covenants and why? As the rating agencies will tell you, ratings are not solely based on covenant performance, but all rating factors influence your ability to comply with the covenants.
  3. What makes your capital plan affordable? Every rating committee will ask what the hospital’s future capital needs are and how those capital needs will be supported by cash flow, also known as “capital capacity.” To answer that question, a hospital must understand what it can afford, based on financial projections. Funding sources may require debt, which requires a debt capacity analysis with goals on debt burden, coverage, and liquidity targets. Over the years, better presentations explain the organization’s capital model, outline the funding sources, and discuss management’s tolerance for leverage.

There is always a lot to cover when meeting with the rating agencies and a near endless array of metrics and indicators to provide. As I’ve written before, how you tell the story is as important as the story itself. If you can weave these three themes throughout the presentation, then you will have a greater shot at having your best voice heard in rating committee.

Healthcare CFOs explore M&A, automation and service line cuts in 2024

Posted on by • Posted in Artificial Intelligence, Artificial Intelligence Generative, CFO, Cost Management, Cost Structure, Cybersecurity, Data Breaches, Days Cash on Hand, Financial Performance, Financial Pressure, Financial Reserves, Financial Stewardship, Financial Strength, Financial Viability, Financially Distressed, Market Consolidation, Market Trends, Mergers & Acquisitions, Operating Income, Operating Margin, Operating Margin Drivers, Operating Metrics, Operating Performance, Service Line Profitability, Service Line Rationalization • Leave a comment
https://www.cfodive.com/news/healthcare-cfos-automation-service-line-cuts-bdo-usa/706153/?utm_source=Sailthru&utm_medium=email&utm_campaign=Issue:%202024-02-01%20CFO%20Dive%20%5Bissue:58721%5D&utm_term=CFO%20Dive

Companies grappling with liquidity concerns are looking to cut costs and streamline operations, according to a new survey.

Dive Brief:

  • Over three-quarters of healthcare chief financial officers expect to see profitability increases in 2024, according to a recent survey from advisory firm BDO USA. However, to become profitable, many organizations say they will have to reduce investments in underperforming service lines, or pursue mergers and acquisitions.
  • More than 40% of respondents said they will decrease investments in primary care and behavioral health services in 2024, citing disruptions from retail players. They will shift funds to home care, ambulatory services and telehealth that provide higher returns, according to the report.
  • Nearly three-quarters of healthcare CFOs plan to pursue some type of M&A deal in the year ahead, despite possible regulatory threats.

Dive Insight:

Though inflationary pressures have eased since the height of the COVID-19 pandemic, healthcare CFOs remain cognizant of managing costs amid liquidity concerns, according to the report.

The firm polled 100 healthcare CFOs serving hospitals, medical groups, outpatient services, academic centers and home health providers with revenues from $250 million to $3 billion or more in October 2023.

Just over a third of organizations surveyed carried more than 60 days of cash on hand. In comparison, a recent analysis from KFF found that financially strong health systems carried at least 150 days of cash on hand in 2022.

Liquidity is a concern for CFOs given high rates of bond and loan covenant violations over the past year. More than half of organizations violated such agreements in 2023, while 41% are concerned they will in 2024, according to the report. 

To remain solvent, 44% of CFOs expect to have more strategic conversations about their economic resiliency in 2024, exploring external partnerships, options for service line adjustments and investments in workforce and technology optimization.

The majority of CFOs surveyed are interested in pursuing external partnerships, despite increased regulatory roadblocks, including recent merger guidance that increased oversight into nontraditional tie-ups. Last week, the FTC filed its first healthcare suit of the year to block the acquisition of two North Carolina-based Community Health Systems hospitals by Novant Health, warning the deal could reduce competition in the region.

Healthcare CFOs explore tie-ups in 2024

Types of deals that CFOs are exploring, as of Oct. 2023.

https://datawrapper.dwcdn.net/aiFBJ/1

Most organizations are interested in exploring sales, according to the report. Financially struggling organizations are among the most likely to consider deals. Nearly one in three organizations that violated their bond or loan covenants in 2023 are planning a carve-out or divestiture this year. Organizations with less than 30 days of cash on hand are also likely to consider carve-outs.

Organizations will also turn to automation to cut costs. Ninety-eight percent of organizations surveyed had piloted generative AI tools in a bid to alleviate resource and cost constraints, according to the consultancy. 

“Healthcare leaders believe AI will be essential to helping clinicians operate at the top of their licenses, focusing their time on patient care and interaction over administrative or repetitive tasks,” authors wrote. Nearly one in three CFOs plan to leverage automation and AI in the next 12 months.

However, CFOs are keeping an eye on the risks. As more data flows through their organizations, they are increasingly concerned about cybersecurity. More than half of executives surveyed said data breaches are a bigger risk in 2024 compared to 2023.

Is our collaborative culture slowing down our ability to act quickly? 

Posted on by • Posted in Accountability, Clarity, Collaboration, Collaborative Culture, Decision Making, Decision Making Process, Leadership Culture, Leadership Flexibility, Leadership Implementation, Operating Margin, Operating Metrics, Operating Performance • Leave a comment

https://mailchi.mp/cd8b8b492027/the-weekly-gist-january-26-2024?e=d1e747d2d8

“We have a collaborative culture; it’s one of our system’s core values. But it takes us far too long to make decisions.” A health system CEO made this comment at a recent meeting, giving voice to a dilemma many system executives are no doubt facing. Of course, leaders want their teams to collaborate—in any important decision, we want to hear different voices, consider diverse points of view, and incorporate various areas of expertise.

On the other hand, collaboration takes time, which we don’t have right now. It also can add complexity, be the enemy of clear direction, and muddy accountability. This CEO went on to make an essential connection: “My concern is that this protracted decision making isn’t just a process problem, but that it’s showing up in our results. 

Take performance improvement—we all quickly agreed we need to cut costs, but it’s taking far too long for us to act, and I fear we’ll have trouble holding the new line over time.” She further mused 

“I wonder if this problem is, at least in part, due to how we make decisions. We don’t make them quickly enough, they aren’t clear enough, and we don’t have the most effective system of accountability.”
 


On one hand, traditional hospital culture is rightly grounded in the safety, hierarchy, and tradition of a do-no-harm world. But on the other hand, today’s economic, technological, and competitive environments require an approach to operations, revenue, and growth that has the aggressiveness of a Fortune 50 company. This should not be an either-or situation. Health systems can uphold a culture of safety while also fostering nontraditional values that will drive the organization assertively toward the future – all while committing to change.

Credit and Capital Markets Outlook for 2024

Posted on by • Posted in 2024 Election Issues, ACA, Aging Population, Balance Sheet, Capital, Capital Allocation Process, Capital Analysis, Capital Budget, Capital Expenditure, Capital Financing, Capital Planning, Capital Structure, Cash to Debt, Critical Success Factors, Days Cash on Hand, Debt to Revenue, Financial Stewardship, Financial Viability, Health System, Hospital, Hospital Industry, Key Credit Metrics, Key Metrics, Key Performance Indicators, Medicare, Medicare Advantage, Operating Cashflow Margin, Operating Margin, Operating Margin Drivers, Operating Metrics, Operating Performance, Strategic Balance Sheet Management • Leave a comment
https://www.kaufmanhall.com/insights/article/credit-and-capital-markets-outlook-2024?utm_source=mkto&utm_campaign=tcm-article&utm_medium=em&utm_term=outlook-240125&utm_content=outlook-240125&mkt_tok=NjU0LUNOWS0yMjQAAAGQ4BvXpiLu9UYHmoGO85k4zKLPOBMn7xx4HgGoCWuxKCBTlxPOir6yDwj643FIM86e1G-0qHWUwQ8V8VKzT810xWYroZ6Hy89a7egCMmn69Sgy

For many providers, 2023 provided a return to profitability (albeit at modest levels) following the devastating operating and investment losses experienced in 2022. Kaufman Hall’s National Hospital Flash Report data illustrated generally improving operating margins throughout the year, leveling off at 2.0% in November on a year-to-date basis.

This level of performance is commendable given 2022 and early 2023 margins, although it is still well below the 3% to 4% range which we believe is needed for long-term sustainability in the not-for-profit healthcare world. We may well have reached a point of stability with respect to operating performance, but at a lower level.

The question for hospital and health system leaders is whether this level of operating stability provides sustainability?

From stabilization to normalization

Since the pandemic began in 2020, the progress of recovery has been viewed over three phases: crisis, stabilization, and normalization. In last year’s outlook, we noted that we were in the midst of a potentially multi-year stabilization phase, which would continue to be marked with volatility—including ongoing labor market dislocations, inflationary pressures, and restrictive monetary policies. As we enter 2024, there are signs that we are now at the bridge between stabilization and normalization (Figure 1).

Figure 1: The Three Phases of Recovery from the Covid Pandemic

“The question for hospital and health system leaders is whether that level of stability provides sustainability?”

These signs include evidence that the first two indicators for normalization—a recalibrated or stabilized workforce environment and a return from an erratic interest rate environment—are coming into place. In our 2023 State of Healthcare Performance Improvement survey, respondents indicated that the spike in contract labor utilization that has been a dominant factor in operating expense increases was subsiding. Sixty percent of respondents said that utilization of contract labor was decreasing, and 36% said it was holding steady. Only 4% noted an increase in contract labor usage. Overall employee cost inflation seems to be subsiding as well: for all three labor categories in our survey (clinical, administrative, and support services), more organizations were able to hold salary increases to the 0% – 5% range in 2023 than in 2022.

There is good news on the interest rate front as well. After a series of rate increases in 2023, the Federal Reserve has held steady the last six months and has signaled rate cuts in 2024. Inflation has cooled markedly (albeit not yet at target levels), and employment rates have held steady. The Fed may have achieved a “soft landing” that satisfies its dual mandate of stable prices and maximum sustainable employment. Borrowing costs for not-for-profit hospital issuers have declined nearly 100 basis points in the last two months and we are expecting a return to more normal issuance levels in the first half of 2024.

There are other indications of normalization, including in the rating agencies’ outlooks for 2024. Regardless of the headline, all saw significant improvement in healthcare performance 2023.

The final answer to the question of whether the healthcare industry is entering the normalization phase likely will hinge on the last two indicators. Will we see a return of normalized strategic capital investments, and will we see a revival of strategic initiatives driving the core business (perhaps newly imagined)?

In effect, are health care systems simply surviving or are they thriving?

Looking forward, several factors could either bolster or undermine healthcare leaders’ confidence and willingness to resume a more normal level of investment in both capital needs and strategic growth. These include:

  • Politics and the 2024 elections. When North Carolina—a state that has traditionally leaned “red”—decided to opt into the Affordable Care Act’s (ACA’s) Medicaid expansion in 2023, it seemed that political debates over the ACA might be in the rearview mirror. But last November, former president Trump—currently the leading candidate for the Republican presidential nomination after strong wins in the Iowa caucuses and New Hampshire primary—indicated his intent to replace the ACA with something else. President Biden is now making protection and expansion of the ACA a key part of his 2024 campaign. What had appeared to be a settled issue may be a significant point of contention in the 2024 presidential election and beyond.

Although we do not anticipate any significant healthcare-related legislation in advance of the 2024 elections, healthcare leaders should be prepared for renewed attention to the costs of government-funded healthcare programs leading up to and following the elections. The national debt has increased rapidly over the past 20 years, tripling from $11 trillion in 2003 to $33 trillion in 2023. If the deficit and national debt become an important issue in the election, a move toward a balanced budget—akin to the Balanced Budget Act of 1997—post election could lead to further cuts to Medicare and Medicaid.

  • Temporary relief payments. Health systems continue to receive one-time cash infusions through the 340B settlement, Federal Emergency Management Agency (FEMA) payments and other governmental programs. Approximately 1,600 hospitals have or will be receiving a lump-sum payment to compensate them for a change in the Department of Health & Human Services’ (HHS’s) reimbursement rates for the 340B program from 2018 to 2022, which was ruled unlawful by the Supreme Court in a 2022 decision. The total amount to be distributed is approximately $9 billion and began hitting bank accounts in January 2024.

But what the right hand giveth, the left hand taketh away. Budget neutrality requirements will force HHS to recoup this offset—amounting to approximately $7.8 billion—which it will do by reducing payments for non-drug items and services to all Outpatient Prospective Payment System (OPPS) providers by 0.5% until the offset has been fully recouped, beginning in calendar year 2026. HHS estimates that this process will take approximately 16 years. Is this a harbinger of lower payments on other key governmental programs?

Many hospitals also continue to receive Covid-related payments from FEMA for expenses occurred during the pandemic. In addition, state supplemental payments—especially under Medicaid managed care and fee-for-service programs—are providing some relief. The Centers for Medicare & Medicaid Services has issued a proposed rule, however, that would limit states’ use of provider-based funding sources, such as provider taxes, and cap the rate of growth for state-directed payments. 

As all of these payment programs dry up over the next few years, hospitals will need to replace the revenue and/or get leaner on the expense side in order to maintain today’s level of performance.

  • The hollowing of the commercial health insurance market. Our colleague, Joyjit Saha Choudhury, recently published a blog on the hollowing of the commercial health insurance market, driven by long-term concerns over the affordability of healthcare. While volumes have been recovering to pre-pandemic levels, this hollowing threatens the loss of the most profitable volumes and will pressure hospitals and health systems to create and deliver value, compete for inclusion in narrow networks, and develop more direct relationships with the employer community.

Related, the growing penetration of Medicare Advantage plans is reducing the number of traditional Medicare beneficiaries. Many CFOs report that these programs can be the most difficult with which to work given their high denial rates and required pre-authorization rates. A new rule requiring insurers to streamline prior authorizations for Medicare Advantage, Medicaid, and Affordable Care Act plans may help alleviate this issue; however, it will be incumbent upon management teams to stay ahead of them. Aging demographics are also reducing the percentage of commercially insured patients for many hospitals and health systems, further exacerbating the problem. This combination of fewer commercial patients (who often subsidize governmental patients) and more pressure on receiving the duly owed commercial revenue threatens to be an ongoing headache for management teams.

  • Ongoing impact of the Baby Boom generation. Despite the good news on inflation—and indications that the Fed may begin lowering interest rates in 2024—the economy is by no means out of the woods yet. The Baby Boom generation, which holds more than 50% of the wealth in the U.S. and is seemingly price agnostic, still has many years of spending ahead, in healthcare and general purchasing. This will likely continue to pressure inflation, especially in the healthcare sector, where demand will continue to grow. As the generation starts to shrink, the resulting wealth transfer will be the largest ever in our country’s history and have profound (and unforeseen) consequences on the overall economy and healthcare in general.

In sum, these other factors will continue to affect the sector (both positively and negatively) and require health system management teams to navigate an everchanging world. While many signs point toward short-term relief, the longer-term challenges persist. Improvements in the short term may, however, provide the opportunity to reposition organizations for the future.

How hospitals and health systems should respond

Healthcare leaders should view ongoing uncertainty in the political and economic climate as a tailwind as much as a headwind. This uncertainty, in other words, should be a motivation to put in place strategies that will buffer healthcare organizations from potential bumps in the road ahead. Setting balance sheet strategy should be a part of an organization’s planning process.

How an organization sets that strategy, measures its performance, and makes improvements will set apart top-performing organizations. 

Although heightened debt issuance early in 2024 signals a return for many systems to a climate of investment, there is still limited energy around strategy and debt conversations in many boardrooms, especially in those organizations where financial improvement continues to lag. The last two years have illustrated that hospitals and health systems will not be able to cut their way to profitability. Lackluster performance cannot and will not improve without some level of strategic change, whether it is through market share gains, payer mix shift, or operational improvements. This strategic change requires investment and investment requires capital. Capital can be obtained in many forms—whether through growth in capital reserves, improved cash flow, or new debt issuance—but is essential for change. Reengaging in conversations about strategy and growth should be an imperative in 2024 and will require reexamining how that growth is funded.

Healthcare leaders should engage their partners as they continue or refocus on:

  • Changing the conversation from debt capacity to capital capacity. Management teams need to determine what they can afford to spend on capital if the new normal of cash flow will be constrained going forward. Capital capacity is and should be agnostic to the source of that capital, such as debt, cash flow from operations, or liquidity reserves. Healthcare leaders must focus on what they can spend, before deciding how to fund that spending. The conversation will need to balance investment for the future with maintaining key credit metrics in the short term.
  • Conducting a capitalization analysis. Separate but related to the previous entry, how much leverage should your organization have relative to its overall capitalization? Ostensibly, many organizations have been paying principal while curtailing borrowing needs, so capitalization may have improved. While that may be the case, many organizations have depleted reserves and/or experienced investment losses that have reduced capitalization. Understanding where the organization stands is an essential next step.
  • Evaluating surplus return. Consider surplus return as investment income net of interest expense. Organizations should evaluate their ability to reliably generate both operating cash flow and net surplus. How an organization’s balance sheet is positioned to generate returns and manage risk will be a critical success factor.   
  • Focusing on the metrics that matter. These include operating cashflow margin, cash to debt, debt to revenue, and days cash on hand. As key metrics for rating analysts and investors continue to evolve, management teams need to make sure they are focused on the correct numbers. The discussion should be dually focused on ensuring adequate-to-ample headroom to basic financial covenants as well as a comparison to key medians and peers. Strong financial planning will address how these metrics can be improved over time through synergies, growth, and diversification strategies.

Although it has been a difficult few years, hospitals and health systems seem to have moved onto a more stable footing over the last twelve months. In order to build upon the upward trajectory, now is the time to harness strategy, planning, and investment to move organizations from stability to sustainability.