Heartburn for Chicago's Northwestern Memorial

Northwestern Memorial HealthCare has suffered its first quarterly operating loss in at least four years, a nearly $24 million setback that reflects the dual challenge of flattening revenue and rising expenses faced by even the largest hospitals.

Anchored by an 894-bed medical center in Streeterville, the two-hospital system lost $23.6 million in the fourth quarter of fiscal 2012, compared with operating income of $6.4 million a year earlier, according to new financial statements. Quarterly operating losses are rare for healthcare networks the size of Northwestern, with revenue of $1.70 billion in the year ended Aug. 31. Diverse revenue from hospital admissions, outpatient procedures and doctor's office visits typically makes the biggest systems immune to short downturns.

Northwestern executives say they expected the loss. The fifth-largest healthcare system in the Chicago area, based on revenue, has a powerful balance sheet, with $2.77 billion in cash and investments. Its flagship medical center raked in $1.47 billion in fiscal 2012, more than any single hospital in the state. Yet the rough patch reflects the mounting obstacles confronting not only Northwestern CEO Dean Harrison, but every hospital chief executive.

“If rough seas are ahead, and if what we're seeing with Northwestern is a larger trend in healthcare, what does that mean for all the other boats in the water?” says Adam Lynch, vice president of Principle Valuation, a Chicago-based healthcare appraisal firm. “Will they be able to navigate the choppy waters that we're going into?”

Hospital CEOs are under mounting pressure from insurance carriers, which are trying to slow the rapid pace of fee increases. Meanwhile, the Obama administration's landmark healthcare law is expected to add pressure on hospital fees. Looming cuts to Medicare as part of a federal budget deficit deal would sap more strength from hospitals' top-line growth.

Expenses, including labor costs, which typically gobble up at least half of nonprofit hospital revenue, continue to climb.

Northwestern has not been immune to those trends. Since fiscal 2010, when it acquired Lake Forest Hospital, operating expenses have jumped 12.6 percent, while total revenue has risen 9.1 percent, after adjusting for an accounting change.

In the fiscal fourth quarter, total revenue increased just $500,000, to $430 million, from a year ago. Meanwhile, overall operating expenses jumped 7.2 percent, to $453.6 million, from $423.1 million, financial statements show. Other expenses accounted for $8.6 million of the loss, but benefits expenses, salaries and professional fees were also up.

The healthcare system is taking steps to return to operating profitability. In August, Northwestern eliminated 230 of the 7,000 positions at its flagship hospital and announced an ambitious effort to slash hospital costs by 25 percent by 2017.

Including nonoperating items such as investment returns, Northwestern posted a gain of $17 million during the fourth quarter.

Northwestern executives decline to be interviewed. In a statement, Chief Financial Officer Peter McCanna says: “The operating loss reported in the fourth quarter was a result of planned expenses occurring in the final quarter of our fiscal year. Operating income performance for the 12-month period ending Aug. 31, 2012, was positive and favorable to budget.”

Northwestern recorded operating income of $88.3 million in fiscal 2012, about $5 million less than 2011.

The fourth-quarter loss was the first for Northwestern since at least the third quarter of 2008, financial statements show.

Crain's reviewed quarterly statements for the five largest Chicago-area health care systems, based on 2011 revenue, since 2009. Northwestern is the only one of the five to post a quarterly operating deficit, Crain's found. But it isn't the only one whose operating margins narrowed.

Rush University Medical Center group's operating income fell 30 percent to $69 million in the fiscal year ended June 30, from $98 million in 2011, as expenses climbed faster than revenue. Higher costs were partly due to Rush's new butterfly-shaped hospital, which opened in January.

Advocate Health Care's revenue rose only 4.6 percent, to $3.44 billion, during the first nine months of 2012, compared with 2011. But the state's largest system's operating expenses rose 5.0 percent, to $3.25 billion.

Challenges to hospitals in general include cuts to Medicare and Medicaid, the rising costs of employing physicians and the large number of patients qualifying for charity care, Advocate CFO Dominic Nakis says.

“These items . . . will exert downward pressure on all providers' operating revenues and results,” he says in a statement.



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