Chicago-based CommonSpirit Health, one of the largest nonprofit healthcare systems in the country, reported an adjusted operating loss of $291 million on revenue of $8.9 billion for the first quarter of fiscal 2024, ending Sept. 30.
The adjusted figure reflects the effects of the California provider fee program. Without such an adjustment, the system reported an operating loss of $441 million versus a $23 million gain the previous year.
The adjusted figures compared with an operating loss of $227 million in the same period last year with revenue of $8.5 billion. Salaries and benefits increased $174 million over the prior year period, or 3.9%.
The overall net loss for the 142-hospital system totaled $738 million as CommonSpirit reported net investment losses of $289 million.
“Despite significant industry and economic headwinds, CommonSpirit was able to extend the momentum achieved in the previous quarter,” CFO Dan Morissette said in a statement. “While this is encouraging, we take nothing for granted. More efforts are underway to provide the strong financial foundation this health ministry needs to provide care to everyone in the communities we serve, including the most vulnerable.”
The New York Times last month published an analysis of Medicare spending trends and concluded that, contrary to the program’s budget busting reputation, annual cost growth has been moderate over the past decade or so. The implication is that the scramble to find more Medicare savings to narrow current and projected federal deficits should be reevaluated, given that previous predictions of runaway costs were off the mark. It’s a comforting picture, especially to those who would prefer to expand Medicare. But does the Times provide the full story?
Medicare is a vast and complex program that, at any given moment, has pressures pushing costs both up and down. Analysts need to look at the full picture to get a balanced view of what is underway.
Even if per person cost escalation has moderated (which it has), many previous years of very high-cost growth already increased the program’s total outlays to a very high level, and there is no real prospect of a reversal. Moreover, the reasons for the current slowdown may not be sustainable: For example, payments per service under current law are not expected to keep up with inflation and therefore may not be sufficient to ensure full access to care for the program’s beneficiaries. With aging baby boomers pushing enrollment up from 66 million today to 83 million by 2040, aggregate costs will grow very rapidly over the coming three decades under almost all realistic scenarios.
In other words, much as many elected officials might wish otherwise, the problem of high-cost entitlement programs outpacing government revenue remains central to the growing risk of a fiscal crisis.
Parsing the data.
The Times piece charts real per capita spending since Medicare began paying for services in the 1960s, with a focus on what has occurred this century. It suggests a slowdown in real spending per capita since 2011 has already provided substantial relief to the federal budget.
The authors calculate that if spending had continued to escalate after 2011 at the same rate as it did previously (it appears the reference period runs from 2000 to 2011), then aggregate Medicare expenditures from 2011 to 2023 would have been $3.9 trillion higher than what was actually spent. The cited figures imply that the spending trend against which actual spending should be compared—the yellow line in the graph below—is 4.4 percent annual growth. If that was indeed avoided after 2011, then the budget did benefit substantially from a slowdown in Medicare spending.
But while a slowdown happened, it was less dramatic than the Times implies. Though fully replicating the figures used in the reporting is difficult without additional information, it’s possible to make a similar assessment based on publicly available data. That reveals a somewhat different picture.
As the Congressional Budget Office (CBO) has noted, when making a calculation of per capita trends in the period after the turn of the century, the addition of drug coverage to Medicare expenditures starting in 2006—the largest benefit expansion since enactment in 1965—distorts calculations of average annual growth rates.
According to data from official national health expenditure (NHE) tables, nominal per capita spending growth in Medicare was 16.5 percent in 2006, when the drug benefit was first implemented. (Congress passed the legislation in 2003.) With economy-wide inflation then running at 2.7 percent, the jump in real per capita spending that year was 13.8 percent. In 2005, it was 3.8 percent; in 2007, 2.3 percent.
Based on this same NHE data, the average annual growth rate from 1996 to 2011 (not counting the one-time effects of the Medicare expansion in 2006), was about 2.5 percent, far below the 4.4 percent assumption used in the Times.
Using this lower estimate of real per capita growth drastically affects the main conclusion. If real Medicare per capita spending had grown by 2.5 percent over the period 2011 to 2023, the added spending relative to what actually occurred would have been about $2.3 trillion, not $3.9 trillion.
The trend started before 2000.
While the spending slowdown in Medicare was less pronounced after 2011 than the Times suggests, it did occur. However, the change began long before 2010, and even before 2000.
According to NHE data, between 1987 and 1996, the average annual real per capita growth rate within Medicare was 5.2 percent. From 1996 to 2005, the rate was cut roughly in half, to 2.7 percent. From 2006 to 2022, it dropped again, to 0.7 percent.
Why did the downward trend begin nearly three decades ago and not in 2011?
While there are likely many explanations, the most obvious is the steady implementation of congressionally-mandated payment reforms (and cuts). When Medicare began offering insurance coverage, it paid for services based on reported costs from providers. Hospitals and physicians would file claims documenting what they spent when caring for program beneficiaries, and Medicare would send them checks with few questions asked. This fueled hyperinflation: From 1970 to 1980, Medicare spending per person grew at an average annual rate of 13.4 percent.
After some uncertainty about possible remedies, Congress settled on a strategy in the 1980s. Instead of paying providers based on their self-reported costs, Medicare would pay for services using formulas designed to provide fair reimbursement for the average patient, and the payment amounts would be set in advance of any care being offered.
The switch started with the prospective payment system (PPS) for inpatient hospital care in 1983, and then was applied using separate provider-specific constructs to physician services (1992), skilled nursing facilities (1998), home health (2000), hospital outpatient care (2000), and much else.
In addition to these broad reforms, Congress regularly imposed cuts in the inflation factors used to increase payment rates each year. These provisions were included in the many broad deficit-cutting bills that were approved during this era.
By the mid-1990s, the cumulative effect of these cuts began to pinch as there were fewer and fewer revenue-enhancing options to offset the strict controls of the regulated payment systems.
Additional factors.
While the slowdown in per capita spending growth began well before 2011, it did intensify over the past decade.
There are likely several reasons for the improvement, some of which were mentioned in the Times’ assessment while others were not:
Deep provider cuts. The Affordable Care Act, along with 2015 legislation that reformed Medicare’s physician fee schedule, severely restrained provider payments over the past decade. In the ACA, the annual inflation adjustment for hospitals and other institutional providers was cut on a permanent basis by a “productivity adjustment” of approximately 1.0 percentage point every year, which is an approximation of the improvement in productivity observed in the national economy every year. But productivity improvement in the health sector is usually much less, and the actuaries assume it will average 0.4 percent annually in the future. In a separate law, Congress tightened the screws further by limiting the annual fee increases for physician services over several years to rates that are also well below general inflation.
These cuts have had a sizable cumulative effect. The savings are now so substantial that Medicare actuaries have been warning for years that they are unsustainable. In a memo released alongside the Trustees’ report each year, actuaries document that the divergence between Medicare and commercial payments for hospital and physician services will grow rapidly with the annual implementation of new cuts. By 2040, Medicare’s payments for physician services and hospital care are expected to be just 40 percent and 55 to 60 percent, respectively, of the average amounts paid by commercial insurers.
The strain is also leading to a political response. Pressure is now building to bump up reimbursements for care, which would have the effect of increasing real per capita cost growth.
Enrollment shifts. The baby boom generation began retiring over the past decade. In 2008, 43 percent of the 65 to 74 population was enrolled in Medicare. By 2021, it had grown to 50 percent. The surge in younger enrollees, with lower than average costs, also may be affecting per capita trends.
Better adherence to effective therapies. As noted, Medicare began covering outpatient prescription drugs in 2006, and the CBO concluded some years after the law was implemented that it was having a positive effect on health outcomes by improving adherence to effective therapies. Moreover, these improvements in health status were lowering the use of non-drug services, with every 1.0 percent increase in drug use reducing other medical care costs by about 0.2 percent. This reduction in future spending growth is noticeable, but it is unlikely to fully offset the effects of building a legislative expansion of Medicare (as occurred with drugs in 2006) into the baseline spending projections.
Medicare Advantage spillover effects. Much has been made about the excessive payments made to Medicare Advantage (MA) plans—the private insurance options offered to program beneficiaries in lieu of the traditional government-administered benefit—based on a flawed system of risk adjustment. There has been less focus on the consistent findings of researchers that higher market penetration by MA produces spillover savings in the government option. A recent study found that every 10 percentage point increase in MA penetration was associated with sizable reductions in post-acute care for patients with congestive heart failure when the markets also included medium to high use of accountable care organizations, which are provider-led managed care arrangements operating under the government-administered umbrella.
The bigger picture.
While the Times provided less than a full view of per capita cost trends, it was not wrong about an improvement. Real per capita spending in Medicare has not been rising as fast since 1995 as it did during the program’s first three decades.
But the Times misses the broader fiscal context. Even with moderate year-to-year rises in spending (which may not last), the federal government’s budgetary outlook has been rapidly deteriorating. Medicare is one reason for the trend. Program spending has grown faster than the revenue and premiums dedicated to Medicare for many years, and the gap will widen as the population ages.
According to Medicare trustees, total program spending in 1980 was 1.4 percent of GDP, with revenue and premiums coming into the program equal to 0.9 percent of GDP, which covered about two-thirds of the spending. By 2010, program expenditures were up to 3.5 percent of GDP (in part because of the new drug benefit) but program receipts had only risen to 1.9 percent of GDP, which only covered a little over half of the total cost. This gap between spending and receipts has continued to widen, and it will become especially problematic as the population ages. There were 28 million Medicare beneficiaries in 1980. By 2040, there will be more than 83 million.
It all adds up to a major fiscal challenge. CBO’s current long-term forecast shows the federal debt rising to above 180 percent of GDP in three decades, with the growing costs of Social Security and Medicare as principal reasons for the added borrowing.
Policymakers should take some comfort from the fact that, as the Times shows, it is possible to restrain Medicare spending with strong controls and incentives for more efficient care delivery. But one should not risk becoming complacent. With the government borrowing at levels that have no precedent in the nation’s peacetime history, it is inconceivable that a correction will occur without further changes to Medicare.
I wrote an Industry Insights article last year about large health system mergers on the heels of the announcement that behemoths Advocate Aurora and Atrium Health were coming together. That transaction closed in December of 2022 and since then, we have witnessed numerous other “mega-mergers,” creating health systems with well over $5 billion in revenue.
With the operating environment for hospitals becoming even more challenging, is getting bigger the solution?
Before we answer that though, let’s take a brief look at the large mergers that have occurred over the past few years.
In 2021, Spectrum and Beaumont in Michigan announced they were coming together to create a $15 billion revenue system now known as Corewell Health. Intermountain and SCL Health came together to create a $15B system; Illinois systems NorthShore University Health and Edward-Elmhurst Healthcare ($5B); in Pennsylvania, Jefferson Health closed on its merger with Einstein Healthcare Network ($8B); Piedmont Healthcare + University Health Care + 4 HCA hospitals in Georgia ($5B); and North Carolina-based Novant Health closed on its merger with New Hanover Regional ($6B).
In 2022, the keynote merger was Advocate Aurora and Atrium Health coming together to create a $27 billion multi-state system. There were also other sizeable combinations such as the University of Michigan Health and Sparrow Health ($7B), South Dakota-based Sanford Health and Minnesota-based Fairview Health ($14B), though that merger has since been called off, Wisconsin’s Marshfield Clinic and Minnesota’s Essentia Health ($5B), and Wellstar Health and August University Health in Georgia ($6B).
So far in 2023, the most notable is Kaiser Permanente’s acquisition of PA-based Geisinger Health, which will take the combined system to over $100 billion in revenue. Other mega-mergers include BJC Health and St. Luke’s Health System in Missouri ($10B), Froedert Health and ThedaCare in Wisconsin ($5B), and most recently, Oregon Health & Science University and Legacy Health ($7B).
So why are these systems merging?
For starters, there is the benefit of geographic and revenue diversification. Some markets are more challenging than others, with diversification across a larger footprint helping to balance the combined systems. Plus, scale allows the systems to more effectively manage risk. With the need to compete in a value-based care world, health systems must operate in markets that are large enough to be effective.
Of critical importance, and another key driver behind these mergers, is the enhanced ability to invest in technological capabilities. It is important to note technology investments cannot be funded through traditional tax-exempt debt and as technology plays a more important role in the delivery of healthcare, not-for-profit systems must make investments to remain competitive. AI, data security,
revenue cycle, innovation, information sharing, etc. are all necessary for the successful delivery of healthcare. Furthermore, not every health system can source, invest, or build the right technology on its own. By combining, systems improve upon their ability to lower their per unit cost of investment in technology.
There is also the people. Human talent is a sought-after resource for hospitals these days and the business of running hospitals has only gotten tougher. Not every health system can attract the best leaders. By merging, health systems can leverage the capability set from across the organization to more effectively manage the business. Another reason is the enhanced capital access. As rates rise and lenders tighten standards, bigger is better; and larger balance sheets with greater assets and security enhances borrowing capabilities. However, capital access does depend on financial performance, so it requires earnings creation. The jury is still out on the back-office savings created by these mega-mergers, but over time, with effective leadership, the right technology, and the necessary scale, achieving synergies must be a motivating factor. But do mergers actually achieve these goals? I have not yet found an independent study to answer this question as many megamergers are recent and there are many variables that influence the analysis. While an n of 1 would not be acceptable to my actuarial wife, there are examples that show promising signs. In my home state of NJ, the 2016 merger between Hackensack and Meridian is notable. Leading up to the merger, Hackensack had $1.7 billion in revenue and was averaging 9% operating EBIDA margins, 150 days cash on hand, and 1x cash to debt. Meridian had $1.6 billion in revenue and was averaging just over 11% operating EBIDA margins, 240 days cash, and 1.4x cash to debt. Post-merger, the combined system now has $6.6 billion of revenue and not taking into the account the recent swings during and post-COVID, was averaging 11% EBIDA margins, 270 days cash, and 1.6x cash to debt. For the combined Hackensack Meridian Health System, 1+1 > 2. They have grown faster, plugged weaknesses, improved their balance sheet, all while continuing to make investments. There are many reasons why large systems are pursuing mergers and why we expect to see more. And one of these mega-mergers could create another competitor to the national for-profit operators like HCA or the large catholic systems like Ascension, CommonSpirit, Providence, or Trinity.
Medicare starts a long road to cutting prices for drugs, starting with 10 costing it $50.5 billion annually – a health policy analyst explains why negotiations are promising but will take years.
The Biden administration released on Aug. 29, 2023, a list of the first 10 drugs that will be up for negotiations with pharmaceutical companies over their Medicare prices.
The drugs are purchased through Medicare Part D, a prescription drug coverage program for Americans ages 65 and older. The 10 medications accounted for more than US$50.5 billion in gross costs between June 1, 2022, and May 31, 2023.
The top 10 list includes such drugs as Johnson & Johnson’s Xarelto, which treats blood clots, and Amgen’s Enbrel, which treats rheumatoid arthritis and psoriasis.
Negotiations are expected to begin in October and continue until August 2024, with lower prices going into effect in 2026.
As a scholar who researches the politics of health policy, I’m skeptical that Medicare drug price negotiations will end up making as big a difference as Democrats have promised, at least in the near future. While U.S. prescription drug prices are excessive, the true potential of the policy is unclear, as it remains muddled in lawsuits and industry opposition. However, if it can withstand the ongoing attacks and become settled law, Americans ages 65 and up could see real financial relief down the line.
Cutting drug costs for Medicare enrollees
The Inflation Reduction Act allows the Centers for Medicare & Medicaid Services to negotiate prices with the companies that make some of the most expensive drugs in the Medicare program, including life-saving cancer and diabetes treatments like Imbruvica and Januvia.
If the negotiations proceed as planned, the drug-price-negotiation provision is expected to save the U.S. government about $98.5 billion by 2031 by allowing it to pay less on prescription drugs for Americans on Medicare – nearly 66 million people. The Biden administration hopes that these cost savings will be passed down to Americans 65 and older through reduced Medicare Part D premiums and lower out-of-pocket costs.
The Inflation Reduction Act provides additional benefits for older Americans, including limiting their out-of-pocket expenses for prescription drugs to no more than $2,000 annually, limiting the growth of Medicare Part D premiums, eliminating out-of-pocket costs for vaccines and providing premium subsidies to low-income people ages 65 and older.
Pharmaceutical companies have to sign agreements to participate in the upcoming negotiations by October 2023. Based on criteria such as public feedback and consultation, as well as the clinical value of the drug, the Centers for Medicare & Medicaid Services will make an initial price offer in early 2024, with the potential to further negotiate the price until August 2024. Going forward, additional drugs will be subject to negotiations.
If drugmakers don’t negotiate, they will face stiff penalties in the form of a tax, reaching as high as 95% of U.S. pharmaceutical product sales. Alternatively, the companies may pull their drugs from the Medicare and Medicaid markets, meaning that seniors on Medicare would lose access to them.
Why US drug prices are so high
Americans pay substantially more for prescription drugs compared with people who live in countries with similar economies, like Germany, the U.K. and Australia. While Americans spent more than $1,100 a year in 2019, Germans paid $825, the British paid $285 and Australians paid $434 per person.
For example, Dulera, an asthma drug, costs 50 times more in the U.S. than the international average. Januvia, a diabetes drug that is among the first 10 drugs up for price negotiation, and Combigan, a glaucoma drug, cost about 10 times more.
Even if the drug price negotiations survive the industry’s legal challenges, it’s possible that future Republican administrations won’t embrace or enforce this policy. This is because potential Republican wins in the 2024 presidential and congressional elections could unravel or severely curtail the new drug negotiation policy. Indeed, Republicans have been working feverishly on designing a strategy to use the negotiations against Democrats in the upcoming elections.
Weighing the prospects
In my view, the government’s efforts to cut prices for prescription drugs that Part D enrollees obtain are a step in the right direction. For now, the effect will likely be small because patients already receive discounts on the listed drugs, bringing the net savings down substantially. However, the potential for real savings for Americans ages 65 and older will undoubtedly grow as more drugs become subject to negotiation.
At the same time, drug manufacturers have indicated that they are willing to take their legal battles against the Medicare drug pricing reform all the way to the Supreme Court. If that happens, there’s a good chance they will prevail because the arguments made in their lawsuits are likely to appeal to the Supreme Court’s conservative majority, which has been favorable to many of the arguments made by drugmakers in their lawsuits.
It’s also too soon to know if this is going to be a win for American patients overall. It’s possible that Americans who aren’t covered by Medicare may actually see prices go up. That’s because if drugmakers do make less money on drugs for people enrolled in Part D, they might make up for those lost profits by charging more for drugs that other people depend on.
And lastly, it’s possible that there will be fewer new prescription drugs – as an indirect result of this policy that’s supposed to improve access to health care – because it may reduce drugmakers incentives. While the number of cases is likely small, it would potentially take a toll on patients who might have seen a cure to their disease – or some relief from their symptoms.
Healthcare is a capital intense industry: facilities, technologies, workforces, infrastructures and clinical breakthroughs require access to funding from banks willing to lend and investors willing to bet.
For most, being a limited partner in a private equity fund is an attractive hedge against inflation, especially a fund that targets healthcare wherein demand is increasing and shifting, costs are soaring and consumers are receptive to new alternatives.
Private equity is big business:
Private equity funds have nearly $2 trillion in dry powder to invest. The Securities and Exchange Commission (SEC) recently reported that private funds’ gross assets now surpass those of the commercial banking sector at more than $25 trillion–up from $9 trillion in 2012. And the American Investment Council reports that…
· 12 million are employed at Private Equity-Backed Companies.
· 32,041 Private Equity-Backed Businesses have been funded since 2017.
· 34 million Americans Depend on Private Equity to Support Their Retirements.
In 2021, the Medicare Payment Advisory Commission (MedPAC) released a report affirming that private equity investments “play an important role providing hospitals, nursing homes, and physician practices with capital and expertise to navigate an increasingly complex health care landscape” but offered Congress no recommendations about how to navigate its growing role.
The playbook for PE investing in healthcare services is widely-known:
· Thesis: Healthcare is expensive, wasteful and unsustainable in its current structure: Incumbents in healthcare services, especially hospitals and physicians, need capital to survive and are receptive to private money.
· Strategy:Land, Expand, and Exit in 5-7 years: Leverage debt at competitive rates to fund most of the deal; operate aggressively by lowering operating costs; grow revenue aggressively thru adjacency acquisitions and partnerships; price aggressively and avoid compliance penalties associated with safety or quality issues.
· Keys to success: Timing, attractive deal terms, a scalable operating platform, exceptional CEO and dispassionate exit strategy. And for navigating expectations of limited partners (high net worth individuals, pension funds, et al), the General Partner gets a 2% management fee and 20% of the value created in the enterprise at exit.
My take:
For the past decade, PE investments in distressed hospitals, medical specialties (radiology, dentistry, dermatology et al), outpatient surgery/ diagnostic facilities and logistics solutions have been popular targets. Going forward, opportunities in services will increasingly center on business models that produce significant, near-term cost-reduction compared to alternative solutions as issues around affordability and employer health costs mount. But three issues will impact the role and success of PE investing in healthcare services looking ahead:
1-Heightened Regulatory Scrutiny: There’s growing concern in Congress and among regulatory agencies about the role of private equity in healthcare services.
· In Congress and in some states, ownership restrictions and added disclosure requirements are being considered.
· The SEC is advancing changes to require added protections for investors in PE funds.
· The FTC is examining the correlation between PE ownership and business practices and consumer choices.
· CMS is considering analyzing the association between PE ownership and prices.
2-The Maturity Wall: “A maturity wall is fast approaching for PE funds that are nearing the end of their term life to distribute their capital back to investors through exits. PE investors will need to pick up their exit pace or will be confronted with 20% to 26% of the capital initially invested by funds to hit the maturity wall. The cumulative amount of still- held investments could grow to over $360 billion in the next 12 years.” (Pitchbook June 30, 2023). The maturity wall will be especially problematic in communities where medical practices and/ancillary services providers acquired thru PE-sponsored deals are forced to switch owners necessitating possible disruptions in care.
3-Heightened Competition among PE Funds: PE funds compete for good deals and satisfied investors. Bigger funds have advantages over smaller funds i.e., domain expertise, analytic models and access to effective executive talent. The deal landscape in healthcare services has slowed though opportunities remain. It’s a buyer’s market prompting intensified competition between funds and aggressive negotiations between buyers and sellers. Qualified investors are comparing fund performance and moving funds to the most successful.
The healthcare services market in the U.S. is worth $3.5 trillion and is forecast to increase at 5%/yr. for the next decade. It’s traditionally dominated by nonprofit operators and market conditions that favor incumbents over newbies, bigger over smaller and business to business (B2B) models over business to consumer (B2C). That’s changing. Investor-ownership in healthcare services is increasing. Distinctions between privately operated PE owned hospitals and services providers and investor-owned publicly traded operators are being scrutinized by regulators even as the tax-exempt status enjoyed by not-for-profits is under the microscope.
Access to capital that’s cost-effective is critical to the future of health services providers. PE will be increasingly part of that discussion and with it, added risk.
HENRY KOTULA 