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Into the red

Modern Healthcare's annual Hospital Systems Survey shows not-for-profits posted an overall net loss in 2008; for-profit chains bucked the trend


By Joe Carlson and Vince Galloro
Posted: June 8, 2009 - 12:01 am ET
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Not-for-profit hospital systems lived up to their names in 2008, with heavy investment losses dragging overall net incomes at the systems well below zero, according to the results of Modern Healthcare’s annual Hospital Systems Survey.

The 33rd annual survey, comprising data from 203 multihospital health systems, shows that fiscal 2008 was one of the toughest years in recent memory for the not-for-profits. Taken as a group, the collection of religious, secular, and government-run nonfederal systems had overall net losses totaling $5.9 billion. The average not-for-profit system posted a $31 million net loss in income for the fiscal year.

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The unaudited survey paints a far different story at the dozen for-profit systems that submitted responses. The 12 systems reporting fiscal 2008 results had an average net income of $123 million. The group as a whole, including the nation’s largest investor-owned systems such as HCA, Community Health Systems and Tenet Healthcare Corp., had an overall net income of $1.5 billion.

Taken together, the net losses at the not-for-profits overwhelmed the gains of investor-owned systems, leaving the survey sample with an overall net loss of $4.4 billion.

Executives at investor-owned systems say their performance amid the recent market turmoil was a validation of a business model that’s on the rise in the industry, and some analysts are predicting the recession could hasten a trend of for-profit systems buying up troubled not-for-profit facilities. Leaders at not-for-profits, meanwhile, say that they are looking forward to an eventual market turnaround to at least stabilize, if not rebuild, the investment funds that normally help cover the gaps between the cost of care and low reimbursement rates.

Download the 2009 Hospital Systems Survey report from our Databank/Surveys section, Hospital Systems: 2009.


For-profits typically don’t maintain the large equities portfolios seen at not-for-profits, and they tend not to rely on variable-rate bonding, as not-for-profits do, analysts say. Those differences allowed many investor-owned systems to defy expectations and even show slight gains in profitability and cash on hand in the first quarter of 2009, says Lauren Coste, director in corporate healthcare finance for Fitch Ratings. “We haven’t really seen a huge impact from the economy so far,” Coste says. “It could be that use of healthcare is a lagging indicator, and that as time goes on” patients won’t be able to pay.

Timing the turnaround

Exactly when a turnaround might begin is a matter of wide speculation. Fitch Ratings analysts said in a Jan. 29 report that pressures like rising uncompensated care and declining overall utilization would lead to reduced operating profitability for the next 18 months to three years at not-for-profit systems.

Martin Arrick, managing director in the not-for-profit healthcare group at Standard & Poor’s, says that many observers are expecting to remain in their current positions for the foreseeable future. “I think the heavy blow has landed, in terms of what’s happened to investments, and people are now regrouping. Where we are right now is where we’re going to be for a little bit,” Arrick says. Analysts are still compiling their summer healthcare ratings based on audited fiscal 2008 reports, but Arrick says the Modern Healthcare survey results were not surprising based on what he’s seen already.

Since the start of 2009, observers say their investment portfolios have not seen much net change. January and February saw a continuation of steep declines of the previous year, but progress in March and April undid much of that damage. “We have not rebuilt 2008’s losses, but we have not sustained any additional losses as well,” says Kris Zimmer, senior vice president of finance with 16-hospital SSM Health Care, St. Louis, which dropped from the ninth- to the 10th-largest Catholic system ranked by staffed acute-care beds on the Modern Healthcare list in 2008 after shedding four hospitals. “We need several more months like we’ve had in March and April to rebuild to a position that we were in historically,” he says.

Not-for-profit SSM lost 18.5% of the value of its investment portfolio in fiscal 2008, although Zimmer notes that the system’s fiscal year includes the particularly difficult fourth-quarter investment results for calendar year 2008. Systems with fiscal years ending in July or September may still be harboring some of their worst investment losses for fiscal 2009 balance sheets.

Such economic factors are causing analysts to take dim views of the industry, with S&P issuing ratings downgrades at a rate not seen since the fallout of the Balanced Budget Act of 1997, according to an April 27 report from the ratings service. But typically investment losses alone are not enough to move a rating. When ratings were downgraded, S&P analysts cited significant operating losses—not just investment losses—as the primary reason in more than two-thirds of those cases.

Not all the news from fiscal 2008 was negative. Net patient revenue for the group of systems as a whole increased by 9.2% in the fiscal year, and net revenue rose by 6.3%.

Some individual systems posted large numbers, particularly on the investor-owned side. Community Health Systems, Franklin, Tenn., showed the largest gain in patient revenue of any system, adding $3.7 billion in 2008, a gain of 52% from the year before. Chairman, President and CEO Wayne Smith says the gain was mainly due to the $6.8 billion acquisition of Triad Hospitals in July 2007, a transaction that combined the third- and fourth-largest for-profit systems at the time into what is today the second-largest investor-owned system based on staffed acute-care beds.

“That’s the reason that we had a pretty substantial jump, but our growth rate is still really good,” Smith says. Overall, the 121-hospital for-profit system’s compounded annual companywide growth rate between 1996 and 2008 was 27%, Smith says. On a same-store basis, growth rates hovered between 6% and 10% between 2001 and 2007, and were 6% in 2008, he says.

Besides growing patient revenue, many hospitals are finding positive news in their declining labor costs, primarily from the greater supply of registered nurses who want to work in hospitals (May 18, p. 8).

“There are a lot of registered nurses in the U.S., but in good times, they are less likely to work in a hospital,” says Gary Lieberman, senior healthcare facilities analyst for Wachovia Capital Markets. “In down times, they come back.” That availability is allowing hospitals to hire nurses to replace much more expensive contract nursing services, and that trend should continue for the rest of 2009, he says.

Bad debt

Continuing the trends of past years, the amount of bad debt recorded by most systems continued to rise in fiscal 2008. Bad debt grew for about three-quarters of the systems surveyed by Modern Healthcare. Furthermore, the change in the amount of bad debt accounted for almost 40% of the difference in net patient revenue on average, the survey results show.

According to this year’s survey, overall bad debt rose 9.5% to $25.4 billion in 2008 from $23.2 billion in the previous year, based on responses from 200 systems that provided figures for both years.

View a Modern Healthcare webinar on the future of for-profit chains


Community, which saw the largest rise in patient revenue, also reported the greatest growth in bad debt in total dollars, adding $311 million and leaving its 2008 bad-debt expense at an estimated $1.2 billion. Why so much new bad debt? “The uninsured,” Smith says.

Other forces may be at work. Although widely publicized trends like unemployment are helping drive bad debt, Arrick says some systems are now reporting that up to a third of their bad-debt cases are from patients who have insurance but cannot or do not pay the copayments and deductibles on their insurance plans. “It’s not all homeless people living under the bridge,” Arrick says.

But while Community’s bad-debt growth may be typical of the healthcare industry as a whole, analysts say the for-profit company is defying the trends in investor-owned healthcare, where bad-debt levels are not showing significant percentage jumps above the levels that began elevating in 2003.

Theories abound as to why the highest unemployment rates in 25 years have not increased the bad-debt rate at for-profit hospitals. “Intuitively, of course, you’d think that as the unemployment rate goes up, people lose their health insurance. That’s what gives a lot of people concern,” Lieberman says.

One mitigating factor could be the American Recovery and Reinvestment Act subsidies that pay 65% of COBRA premiums for laid-off workers, Lieberman says. Fitch analysts pointed to enhanced focus on point-of-service payment systems, greater efforts to qualify uninsured patients for Medicaid, and more screening to limit the amount of nonemergency care provided to uninsured patients.

Coste says that immigration trends are another factor. Federal statistics show that emigration from Mexico has dropped significantly during the recession, which may have led to a drop in bad debt because many cases of nonpayment involve migrant workers, she says.

“Although bad-debt expense continues to be stable, Fitch believes this trend will not last” at the for-profit systems, according to the firm’s March 16 report.

Declining profits

Operating margins took a major hit in fiscal 2008, the Modern Healthcare survey shows.

Defined as net operating income divided by net patient revenue, the overall average operating margin at systems in the survey dropped by more than 50% in one year’s time, from 3.6% in fiscal 2007 to 1.6% the following year. “I think that’s a real cut,” Arrick says. “It’s this underlying notion that operations are really under pressure.”

Not-for-profit Baylor Health Care System, Dallas, typifies many of the trends at work in the survey, including the drop in operating margins. Although the 16-hospital system is several times more profitable than the average, its operating margin dropped by a roughly proportional percentage as the group average, going from 11.25% in fiscal 2007 to 6.9% the following year.

Days’ cash on hand at Baylor dropped more than 20% from its highest point during fiscal 2008, which is typical of the range noted by Fitch analysts in a Jan. 29 outlook paper on not-for-profit healthcare. “Implications vary from institution to institution and partially depend on the original liquidity level: a 30% decline is less of a concern for a hospital that started at 250” days’ cash on hand, according to the Fitch outlook, “than for one that started at 100, all else being equal.”

Baylor also took a $125 million loss on its investments, which was about 10% of the system’s portfolio. “If the market ever comes back, we’ll recover all that, but it makes for some interesting paper losses,” says Kitty Mann, vice president of corporate finance at Baylor. “It’s wreaking havoc on balance sheets.”

Despite the shrinking margin and losses in nonoperating revenue, Mann says that Baylor’s bottom line has larger trends working in its favor because market growth is still driving same-store volume while labor costs tend to be lower in Texas than in places like the Northeast. “In some of the markets, back in the Northeast especially, where their labor market is higher than ours and they’re in areas that are not growing, it would be a great cause for concern,” Mann says. “We still have a pretty attractive payer mix.”

For-profit LifePoint Hospitals, Brentwood, Tenn., maintained the highest operating margin of any system on the list, posting a margin of 16.7% in fiscal 2008, down one-half of a percentage point from the year before.

Jeff Sherman, executive vice president and chief financial officer for the 48-hospital system, credits LifePoint’s business model of acquiring smaller community hospitals that are often sole providers in their communities. “Small hospitals … have had to focus on being efficient. We have a long track record of being strong operators of small hospitals,” Sherman says.

Judicious use of debt was another key. In contrast to some of the largest for-profit hospital operators, LifePoint eschews borrowing when it can, retaining internal control over free cash that would otherwise go to make interest payments. “The company has made a conscious decision to keep a conservative balance sheet and maintain low debt levels in comparison with our peers,” he says.

LifePoint announced in February that it purchased 154-bed Rockdale Medical Center, Conyers, Ga., for $80 million. Sherman says that the money for the purchase came from cash reserves.

At the same time, LifePoint invested $160 million in its hospitals in 2008, and executives anticipate a similar level of investment for 2009. Community reported a similar trend, with plans to make about $600 million in capital investments in 2009, compared with $700 million in 2008—a difference attributable mainly to the halting of replacement hospital construction for 2009, Smith says.

Lieberman of Wachovia Capital Markets says that investor-owed hospital companies are reporting that their not-for-profit competitors are cutting capital spending by about 25%, presumably because of investment losses.

The cutbacks come on the heels of a long period of good access to cheap capital that fueled competition in capital spending, Lieberman says. If investor-owned companies are able to exceed the capital spending of their not-for-profit competitors, the question is whether they will gain market share, improve quality or both.

“Potentially, that’s one of the bigger, more impactful stories for the next few years,” Lieberman says.

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