The Dangerous Trend Of Hospital Costs Outpacing Revenue Growth Rates

A recent research report from Moody’s Investors Service noted that not-for-profit hospital revenue growth rate have been increasing at a slower rate than expenses, leading to shrinking profitability margins.

While there has been a slowdown in the growth rate of costs at not-for-profit hospitals, the reduction in the revenue growth rate was even faster in 2017 according to the report. As this article from Alex Kacik at Modern Healthcare reports:

“The median annual expense growth rate fell from 7.1% in 2016 to 5.7% in 2017 but annual revenue growth declined faster, from 6.1% to 4.6%, despite increased merger and acquisition activity, according to Moody’s Investors Service.

While not-for-profit hospitals have curtailed labor and supply costs, lower reimbursement rates, the shift to outpatient care and increased ambulatory competition have shackled revenue.

This marks the second consecutive year expenses outpaced revenue, which will remain the largest strain on not-for-profit hospital profitability through 2019, Moody’s analysts said.

“This is no longer solely about expense reduction. If not-for-profits just focus on that, they will be out of business in the next few years,” said Lyndean Brick, president and CEO of healthcare consultancy the Advis Group. “They have to grow volumes, be creative and do things differently than they have done.”

While not-for-profit health systems have started to curb expenses, more should look to grow volumes by embracing physician-led ambulatory surgery centers, bolstering managed-care plans, doing more direct contracting and monetizing operations like food services, Brick said.

Median Medicare and Medicaid payments as a percentage of gross revenue slightly increased to 45.6% and 15.5% in 2017, respectively, while the higher-paying commercial sector nudged down to 31.9%, according to Moody’s. Government payers’ share of hospital revenue will likely increase as the population ages, which has manifested in each of the last five years.

Notably, less than 3% of net patient revenue came from capitation and risk-based contracting in 2017. Most reimbursement was derived from diagnosis-related group payment (41%), fee schedule (28%) or from a percentage of the chargemaster or list price (17%).

“They have to monetize their assets,” Brick said. “They have to look at nontraditional revenue as a key driver in their future success.”

Moody’s expects more margin pressure through 2018 after median margins fell to an all-time low of 1.6% operating margin and 8.1% of operating cash flow. Income from operations was nearly cut in half from 2016 to 2017.

Another emerging trend is a large jump in hospitals with operating deficits and lower operating cash flow in 2017. More than 28% of hospitals reported operating losses last year, which rose from 16.5% in 2016. The 59% of providers reporting lower absolute operating cash flow is more than double the 24% reported in 2015—the highest percentage in five years.

While not-for-profit hospitals have reduced their debt over the last five years, their debt service coverage ratios have softened, Moody’s found. Funding capital needs through debt financing could exacerbate that trend, Moody’s analyst Rita Sverdlik said.

Investment income has provided a buffer, boosting the unrestricted cash and investments growth rate from about 5% to 9%, although that could change if the market turns, she said.

“Reversing sluggish volume trends and growing profitable service lines will be critical to improving the sector’s financial trajectory over the near-term as most hospitals continue to operate in a fee-for-service environment,” Sverdlik said in a statement.

As hospitals revamp their operations, suppliers and vendors also need to be held in check, Brick said.

“It’s important that the healthcare industry underscores a similar cost reduction pressure that hasn’t yet been fully achieved on the supplier and vendor side,” she said. “There needs to be some pressure on them to drop their prices.”

Download a copy of the case study here: Not-for-profit hospitals’ cost-cutting isn’t keeping up with revenue decline

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