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Operating margins stabilize, but not-for-profit hospitals still vulnerable

April 26, 2019 / ALEX KACIK 

Not-for-profit and public hospitals’ revenue growth has edged ahead of expense inflation for the first time since 2015, according to a new report.

Median annual revenue growth rose to 5.1% while expense growth dropped to 5% in 2018, new preliminary data on 150 hospitals from Moody’s Investors Service show. Although hospitals were able to meaningfully reduce their expense growth rate from 7.1% in 2016 to 5.7% in 2017, that didn’t keep up with revenue growth’s decline from 6.1% to 4.6%.

Mergers and acquisitions, steady patient volumes and revenue cycle improvements fueled rising revenue while cost-cutting initiatives, productivity boosts, the shift to lower-cost settings and a slowdown in drug price hikes curbed expenses.

“You are finally seeing some of hospitals’ strategies come to fruition, but there are only glimmers of stability,” Moody’s analyst Rita Sverdlik said. “The pace of decline of profitability margins is slower than it has been in past years, but they are still down.”

Median operating margins reached 1.7% in 2018, down from 1.8% in 2017. A more sustainable operating margin would be around 2.5%, said Christopher Kerns, executive director at the Advisory Board.

“That’s still an anemic margin overall,” said Kerns, which he added was held back by low revenue growth.

Hospitals have doubled down on their efforts to control spending, recognizing it is a permanent rather than temporary necessity, but there are still a number of competitive threats to their businesses, he said. They could also be more disciplined in hiring and reduce their supply costs, Kerns said.

“It does not mean that they are out of the woods yet,” he said.

Median operating income and operating cash flow improved to $13.7 million and $74.4 million, respectively, compared to $11.9 million and $63.9 million in 2017, Moody’s found. Although, operating margins were constrained by relatively flat volumes, ongoing staffing shortages, wage increases associated with lower unemployment and persistent high costs of specialty drugs.

Median growth in inpatient admissions was flat at 1.2% while outpatient growth slightly ticked up to 2.4%. Non-hospital owned outpatient departments offer lower costs in large part due to a lack of facility fees, which the CMS aims to eliminate in its site-neutral payment proposal.

The aging population also dampens hospitals’ revenue, as Medicare now represents 47.2% of gross revenue, up from 45.8% in 2017. Commercial gross revenue declined for the third consecutive year to 31.1%, according to Moody’s.

One of the biggest threats to hospital revenue growth is the outside disruptorspoised to divert referrals and patients from high-cost settings, Kerns said. While emergency room visits increased, the growth rate tipped to the negative for the first time in five years at -0.2% as urgent care centers continued to open across the country, Moody’s researchers said.

Hospitals will either have to offer a lower price or demonstrate a measurable quality difference to rationalize the higher costs, Kerns said.

“They have to embrace fee-for-value because that is where the competition is moving,” said Kerns, citing providers like Medicare provider Chicago-based Oak Street Health. “There are various types of medical groups that specialize in populations of patients that have been thought of as ‘negative margin,’ but the disruptive players don’t view them that way.”

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Chris J. Stewart

Chris currently serves as Chief Operating Officer at Ortho Spine Partners. Prior to that, he was the assistant vice president and business unit leader of Medical Device Management for HealthTrust.

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