Moody’s: Preliminary Medians Show Declining Hospital Profitability

Moody’s Investors Service recently released its preliminary medians for 2017. The results show a continuing decline in not-for-profit and public hospitals’ profitability metrics. Margins hit 10-year lows—falling below levels seen during the last recession.

 

Profitability margins mark 10-year low. The median operating cash flow margin dipped to 8.1% as expense growth outpaced revenue growth for the second consecutive year. This indicator of profitability fell below levels seen during the 2008-09 recession, and Moody’s expects this suppressed level will continue over the next year. Details include:

 

  • Median operating cash flow margin growth was -11.4 percent, the greatest rate of decline in five years.
  • This weakening reflects the increasing gap between revenue growth and expense growth. Expense growth was attributed to labor shortages, technology investments and supply costs. Median annual expense growth exceeded annual revenue growth by 1.2 percent.
  • Revenue growth has been constrained by declining reimbursement rates, a shift to less profitable outpatient care and growth of governmental payers.

 

Moody’s analysts wrote “We expect expense growth will continue to outpace revenue growth over the next year, suppressing margins. New strategies to stimulate revenue growth will be integral as hospitals and health systems exhaust cost reduction efforts.” (Preliminary medians underscore negative sector outlook, Moody’s Investors Service Sector In-Depth, April 23, 2018)

 

Additional contributors to declining profitability included decreasing debt affordability, declining reimbursement and a shifting payer mix.

 

  • Despite a median 1.7 percent decline in total absolute debt, most leverage metrics softened. Operating challenges and increased debt issuance in the fourth quarter of calendar year 2017 will keep debt service coverage measures subdued.
  • Volume growth slowed and median growth in outpatient visits (2.2 percent) continued to outpace median growth in inpatient admissions (1.2 percent).
  • Revenue pressures increased as reimbursement from commercial payers decreased.
  • The aging population, growing bad debt and a lower rate of reimbursement increases will continue to add credit stress.

 

 

(iProtean thanks Moody’s Investors Service for its permission to excerpt portions of its Special Outlook.)

 

 

 

Coming next week: The Volume to Value Paradox featuring Nate Kaufman, Marian Jennings and Dan Grauman. These experts discuss their perspectives of moving from volume to value, the pitfalls to avoid, how to involve physicians, the impact of consolidation and scale on value and the overall challenges of inserting value into the reimbursement formula.

 

 

For a complete list of iProtean courses, click here.

 

 

For more information about iProtean, click here.

Dealing with the Cost Imperative

This week we feature excerpts of a discussion with Marian Jennings of M. Jennings Consulting and an iProtean expert. Marian covers the importance of “doing more with less” and the most effective approaches to reducing costs.

 

 

iProtean: Why should we be focusing so much attention on reducing cost? Don’t we also need to focus on growth?

 

MARIAN JENNINGS: How do you ensure financial viability? It’s a pretty simple equation: Revenues are greater than expenses. So traditionally the way we have been successful financially is we have grown revenue. We need to attract more patients to be successful under the payment models, but I would argue that especially in the short term for most organizations, it is going to be essential that you reduce cost.

 

Now, cost reduction is not an end in itself. I once had a professor who said if your goal is to reduce cost, go out of business. Your cost will be zero and you will have maximized your goal. So we’re not doing cost reduction just because we can or because we can’t think of anything else to do. We’re doing it because we believe that reducing cost improves our value positioning.

 

Value is the relationship between quality, outcomes, affordability, access and cost. So if we reduce cost, that in and of itself, without any changes in our quality or our satisfaction, improves our value positioning.

 

Most organizations need to be looking at reducing their cost over the next five years by at least 10 percent, maybe more. Few organizations actually have identified reductions in that order of magnitude. So the very first step for your board is to actually have the have the finance committee review, and then the board review a five-year financial forecast. The forecast should envision neither the best nor worst case scenarios, but the most likely scenario.

 

Then review what will likely happen to your margins if you continue to offer the same range of services you currently offer and if payment changes the way you envision it will change. From this you can identify the magnitude of the financial gap. And again, it’s typically at least a 10 percent reduction in cost, maybe even 15 percent and, in some cases, 20 percent.

 

iProtean: What approaches to reducing cost will have the greatest payoff for our organization?

 

MARIAN JENNINGS: When I think about reducing cost, I envision this as a continuum and you have to do all of it. I don’t view that you do one thing or you do the other thing, I don’t think there are bad strategies or m-innovative strategies or traditional strategies, I view that you should be trying a number of things simultaneously.

 

You should be trying a number of things simultaneously. Each strategy you pursue will be necessary; none will be sufficient on its own. So I envision those as buckets of strategies.

 

The first bucket is what I would call more traditional, low-hanging fruit. Everyone is pursuing these, you may need to accelerate your pursuit or find new vehicles to achieve it but those are around primarily productivity. So they’re labor productivity, supply chain costs, revenue cycle enhancements. They are very traditional ways that we would try to get at our core infrastructure of cost.

 

You should put this first bucket into the context of the financial gap between what you expect to happen and what you need for financial viability. How much of this gap can be closed through these traditional vehicles?

 

In addition to those traditional approaches to improving your cost position, there are a couple of areas that organizations really need to take a close look at. One is to tackle the overhead, or the fixed costs of the organization. Most hospitals and health systems would view their cost as half-fixed and half-variable. But having 50 percent of your costs as fixed is a very dangerous positioning for the organization. So, boards need to challenge management to look at the overhead costs and the organizational structure.

 

Overhead costs are not only the people in the billing department or in medical records. Every department has fixed costs. Every clinical department has fixed costs: nursing, your physician enterprise, lab, etc. You need to look at the overall fixed cost structure of the organization and reduce it. That may mean reorganizing departments, combining departments, more teamwork across departments. But we really can’t survive in a world where half of our costs are considered untouchable.

 

Another bucket includes reexamining the portfolio of your services including where the services are located. This is particularly true in terms of location for multi-hospital systems, especially ones that are aggregated by individual hospitals and providers coming together where you may have a lot of redundancy of services at multiple locations.

 

Portfolio assessment is not for the faint of heart. It’s incredibly challenging. Are we willing to make the hard decisions once we see the results of the analysis? You’re trying to determine where you should be investing resources to grow, where you might need to close down or shrink a program or divest it in order to free up resources that you can re-deploy. Easier said than done.

 

The third bucket has two components. First is core clinical redesign across the continuum of care .The second major component of these more innovative or transformational approaches to cost reduction is your electronic health record (EHR). Clinical redesign relies on EHR for data to help redesign clinical care.

 

(Marian offers more on the best approaches to reducing costs in the upcoming iProtean course, Doing More with Less: The Cost Imperative.)

 

 

The Board’s Role in Leading Through Transition, iProtean’s latest advanced Governance course, now appears in your library. It features Karma Bass and Marian Jennings on issues such as dealing with uncertainty, new elements for evaluating the CEO, prudent risk-taking, critical questions, recommended practices, destination metrics and changing over time.

 

Coming soon: The Volume to Value Paradox featuring Nate Kaufman, Marian Jennings and Dan Grauman.

 

 

For a complete list of iProtean courses, click here.

 

 

For more information about iProtean, click here.

 

Capital Markets: Balancing Opportunity with Uncertainty

Capital markets, which have been relatively stable over the last several years, have begun a slow but consistent rise in interest rates. This means healthcare organizations should prepare for a higher cost of capital.

 

The outlook becomes confusing, however, because of “recent significant policy developments” from the current congress and administration, notes the author of a recent article in hfm Magazine.

 

“The policy changes, coupled with the dynamic of new players entering the healthcare business, suggest that over the long term the healthcare industry can expect to see new debt structures, new sources, and eventually, new metrics for monitoring and assessing the credit strength of an organization.” (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)

 

Some of the changes will result from the new tax law, others from volatility in the debt and equity markets and changing investors’ perceptions. Nontraditional healthcare organizations entering the healthcare market also will have an impact.

 

Although some minor changes in the status quo for borrowing will occur in 2018 going into 2019, healthcare borrowers can expect to see more radical changes with the ongoing effects of tax reform and the further influx of nontraditional players changing the healthcare business landscape, the author noted.

 

Today, both large and highly rated multihospital systems and urban medical centers, and smaller community and rural hospitals that may be below investment grade or unrated by the major credit rating agencies are experiencing favorable market conditions. However, as policy changes begin to bring about shifts in the cost and availability of capital, the likely future effects of the Tax Cuts and Jobs Act (TCJA) and the Federal Open Market Committee’s (FOMC) recent motions in shaping the new normal are worth considering.

 

The Federal Reserve already has made one interest-rate hike in 2018, and another two are expected this year. So the cost of capital has increased and can be expected to increase further.

 

It’s more difficult to predict the impact of the reduced corporate tax rate on tax-exempt providers. The benefit of tax-exempt debt for hospitals is that the bondholder does not pay taxes on the interest received and, in exchange, accepts a lower interest rate. Note that the relationship between the interest rate and the benefit to the borrower has roughly corresponded to the corporate tax rate.

 

However, with the drop in the corporate tax rate under the TCJA from 35 percent to 20 percent, the benefit of avoiding taxes is reduced, and “if this relationship holds, tax-exempt institutions will see a significant increase in capital costs.” (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)

 

Hospitals and systems should consider changes likely to occur with their tax-exempt direct placement debt. Direct placement refers to debt purchased by a single bank or other investor. The loan documents usually have a clause that notes that a change in the corporate tax rate will trigger an interest rate increase or, in some arrangements, an automatic reissuance of the debt.

 

“Few paid attention to such clauses in years past,” the author noted. (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)

 

In the first quarter 2018, many borrowers received notification that their interest rate would increase by amounts ranging from 0.25 percent to 1 percent. For organizations that are potentially subject to such increases, or that have debt clauses that require reissuances, it may be time to renegotiate the capital structure and gain greater flexibility for managing changes in interest rates, the author wrote.

 

The author concluded, “It is generally believed that, for the near term, average long-term tax-exempt bond fixed rates will continue to range between 4.25 percent and 5 percent. Over the long term, however, the new corporate tax rate will drive the cost of tax-exempt debt further upward. How much and when remain to be seen.” (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)

 

 

 

The Board’s Role in Leading Through Transition, iProtean’s latest advanced Governance course, now appears in your library. It features Karma Bass and Marian Jennings on issues such as dealing with uncertainty, new elements for evaluating the CEO, prudent risk-taking, critical questions, recommended practices, destination metrics and changing over time.

 

Coming soon: The Volume to Value Paradox featuring Nate Kaufman, Marian Jennings and Dan Grauman.

 

 

For a complete list of iProtean courses, click here.

 

 

For more information about iProtean, click here.

 

CMS Reveals New Stance on ACO Risk Contracts and Medicaid Limits

No Medicaid lifetime limits and a hard stance on ACO risk contracts highlighted CMS head Seema Verma’s talk at the American Hospital Association’s recent annual meeting.

 

“We’re determined to make sure that Medicaid remains the safety net for those who need it most,” Verma said. “To that end, we have determined we will not approve Kansas’ recent request to place a lifetime limit on Medicaid benefits.” (“Verma draws the line on Medicaid limits, ACO risk contracts,” Modern Healthcare, May 7, 2018)

 

Healthcare providers have urged CMS to deny Medicaid benefits limits proposed by some states, noting it would significantly increase hospitals’ uncompensated-care costs, as many low-income beneficiaries cycle on and off Medicaid due to unpredictable hours and wages.

 

ACO Risk Contracts

 

ACOs that have taken on risk have saved money, but those in upside-only tracks (no risk) appear to be increasing Medicare spending, according to Verma. ACOs that started in the Medicare Shared Savings Program’s Track 1 in either 2012 or 2013 are supposed to move to a risk-based model by their third contract periods, which begin next year.

 

“The presence of these upside-only tracks may be encouraging consolidation in the marketplace, reducing competition and choice for our beneficiaries,” she said. “While we understand that systems need time to adjust, our system cannot afford to continue with models that are not producing results.” (“Verma draws the line on Medicaid limits, ACO risk contracts,” Modern Healthcare, May 7, 2018)

 

A significant majority (82 percent) of Medicare Shared Savings ACOs has enrolled in upside-only tracks. These ACOs say they need more time without risk because Medicare Shared Savings Program regulations have changed considerably since the early years and ACOs are just now operating successfully.

 

A recent survey by the National Association of ACOs found that many ACOs would quit if they were required to take on risk next year. (“Many Medicare ACOs would quit rather than face risk next year,” Modern Healthcare, May 2, 2018)

 

Verma’s stance may mean there will be an exodus from Track 1, policy insiders said.  One analyst noted the CMS focus on risk would mean a much smaller ACO program that loses less money.

 

Late last month Verma wrote to the National Association of ACOs that “risk-reticent ACOs move to the newly created Track 1+ which has a lower shared loss rate (30 percent) compared to Tracks 2 and 3. (“Verma draws the line on Medicaid limits, ACO risk contracts,” Modern Healthcare, May 7, 2018)

 

But an executive at the National Association of ACOs noted provider concerns about moving to Track 1+ because the shared savings rate is not any higher than Track 1. (“Verma draws the line on Medicaid limits, ACO risk contracts,” Modern Healthcare, May 7, 2018)

 

 

The Board’s Role in Leading Through Transition, iProtean’s latest advanced Governance course, now appears in your library. It features Karma Bass and Marian Jennings on issues such as dealing with uncertainty, new elements for evaluating the CEO, prudent risk-taking, critical questions, recommended practices, destination metrics and changing over time.

 

Coming soon: The Volume to Value Paradox featuring Nate Kaufman, Marian Jennings and Dan Grauman.

 

 

For a complete list of iProtean courses, click here.

 

 

For more information about iProtean, click here.

Internalizing Enterprise Risk Management

As the healthcare market expands and evolves, the inherent risks also are increasing. These risks include:

  • The shift from volume to value
  • The rise of the consumer and expansion of consumer options
  • New payment models
  • Mobile strategies
  • New entrants
  • An aging population
  • Continued political and regulatory uncertainty

 

Whereas hospitals/systems have traditionally done well at risk identification and assessment, analysts wrote in a new report from the Healthcare Financial Management Association that “The industry has been less proficient at prioritizing and managing risk.” To do better, healthcare providers must invest more in building effective enterprise risk management (ERM) capabilities. (“ERM: Evolving From Risk Assessment to Strategic Risk Management,” HFMA’s Healthcare Finance Strategies, April 25, 2018)

 

“By giving an organization insight into how to take the right risks at the right time, an effective ERM program can help the organization more successfully execute its strategic imperatives,” the analysts wrote.

 

Key Components

 

Regardless of the initial ERM maturity level in the organization, an important starting point for developing the program begins with clearly defining or reviewing the program’s purpose and value proposition for key stakeholders. This exercise will help determine whether the current program is effectively serving the organization and is well positioned to drive the level of change needed while managing risk in a dynamic and complex environment.

 

The organization should create a risk culture and governance in alignment with its strategic planning process and build out risk processes with the support of governance, risk and compliance (GRC) technologies.

 

The five key components of the program include:

 

Building a risk culture.  Identifying, understanding and managing risk should be a priority and responsibility of all members of the management team. Risk topics should be part and parcel of day-to-day operations discussions as well as committee meetings and executive team discussions.

 

“Organizational risks should be defined more broadly than simply as events that result in challenges and issues that must be avoided. It is important that all stakeholders within the hospital or health system understand both the risks and opportunities presented, and the uncertainties that need to be balanced to make an informed decision on whether to pursue the opportunity.” (“ERM: Evolving From Risk Assessment to Strategic Risk Management,” HFMA’s Healthcare Finance Strategies, April 25, 2018)

 

Formalizing risk governance. The board, senior management and functional management should have specific roles within the risk-management process and recognize their active roles within the risk-governance process. They should be accountable for their participation in the process, and guides and protocols should be created to clearly define when and how issues of risk are to be escalated.

 

Aligning ERM with strategic planning. To achieve greater alignment to the organization’s strategic planning process, organizational leaders should leverage the results of the risk assessment to promote a discussion around the implications of the risk profile. These conversations ultimately should lead to integration of the ERM processes within key functions such as planning, mergers and acquisitions, and program management for strategic initiatives.

 

Standardizing the risk management process. A standardized risk management process relies on data analysis to define the qualitative and quantitative impact of risk on an organization’s ability to accomplish its strategic initiatives and execute its day-to-day business decisions. Organizational leaders should review all risk scenarios to understand the implications of changing business models, industry events and trends and the interrelatedness and combined impact of risk. Using this information, as well as risk appetite, risk management professionals can incorporate the changes over time and drive further resource allocation discussions.

 

Leveraging GRC technology to capture and coordinate risk management activities. As the risk environment evolves, enhanced and more sophisticated tools help to support an advancing risk management process and improve coordination of core risk management activities. These tools provide greater access to shared data and information across the organization and improve resiliency. (“ERM: Evolving From Risk Assessment to Strategic Risk Management,” HFMA’s Healthcare Finance Strategies, April 25, 2018)

 

 

 

The Board’s Role in Leading Through Transition, iProtean’s latest advanced Governance course, now appears in your library. It features Karma Bass and Marian Jennings on issues such as dealing with uncertainty, new elements for evaluating the CEO, prudent risk-taking, critical questions, recommended practices, destination metrics and changing over time.

 

Coming soon: The Volume to Value Paradox featuring Nate Kaufman, Marian Jennings and Dan Grauman.

 

 

For a complete list of iProtean courses, click here.

 

 

For more information about iProtean, click here.