Managed care huffed and puffed in 1995 but couldn't blow down hospitals' financial houses.
Quite the opposite. By becoming more efficient, hospitals boosted their median operating profit margin to 3.88% in 1995, compared with 3.42% in 1994, according to the 1997 edition of The Comparative Performance of U.S. Hospitals: The Sourcebook. Hospitals' healthy return on operations is one of many indicators of financial strength highlighted in the Sourcebook's 10th-anniversary edition, which has just been published by HCIA, a Baltimore-based healthcare information company, and Deloitte & Touche, a national accounting and consulting firm.
"Frankly, I was surprised at the earnings that were turned in by hospitals," said Michael Engelhart, a partner with the Deloitte & Touche Consulting Group in Chicago. With managed care squeezing hospitals' overall reimbursement and length-of-stay reductions shrinking per-diem payments, most analysts expected a downturn in earnings, he said. "Instead, earnings increased."
Drawing primarily from Medicare cost reports, the Sourcebook provides a five-year financial and operational report card on 3,972 hospitals with 25 or more beds in service. Hospital performance is analyzed through 57 separate measures of fiscal and operational health and is compared among various peer groups. This year's edition also features a 10-year analysis of trends among peer groups.
Over the past decade, hospitals have more than doubled operating margins by growing their outpatient business and controlling costs, the report notes. In 1986, hospitals had an operating margin of 1.72%.
In 1995, hospitals' total profitability also increased, reflecting earnings on investments. According to the Sourcebook, hospitals' median total profit margin grew to 5.33% from 4.51% in 1994.
Engelhart noted a wide difference in operating profit margins of not-for-profit and investor-owned hospitals. In 1995, the median for not-for-profits rose to 3.65% from 3.18% in the prior year. Investor-owned hospitals were significantly more profitable-recording a median operating margin of 9.27% in 1995, compared with 7.1% in 1994.
"I suspect that they're just more aggressive pricers and probably more aggressive in negotiating with managed-care organizations (than not-for-profits)," he said. Also, it didn't hurt that many investor-owned hospitals are located in the southern half of the country, where managed-care penetration isn't as high.
Improved profitability bolstered hospitals' cash position, too. Median days' cash on hand increased for the fifth consecutive year to 54.6 days in 1995 from 48.7 days in 1994. But that is still relatively low, Engelhart said. For an investment-grade rating, analysts typically like to see 90 to 100 days' cash, he noted.
After generating higher profit margins, hospitals' next-best trick may have been their success in reducing expenses. Suzanne Zeuschner, an associate account development officer at HCIA, said 1995 is the first year in a decade that hospitals' median expenses declined. On a case-mix and wage-adjusted basis, hospitals' median expense per discharge dropped to $3,914 in 1995 from $3,935 in 1994.
To Engelhart, the drop in expenses isn't as surprising as the rise in operating profits, considering that many hospitals have undertaken massive cost-reduction and re-engineering programs over the past two years. Those programs have helped shrink staffing, for example. According to the Sourcebook, hospitals had a median 6.1 FTEs per 100 adjusted discharges in 1995, down from 6.3 in the previous year.
Hospitals also whittled the average length of stay to 4.33 days in 1995 from 4.59 days in 1994.
For the most part, though, hospitals have done little to reduce excess capacity by closing facilities or combining programs and services, Engelhart said. There's been little pressure on hospitals to pursue large-scale consolidation opportunities.
"Hospitals have responded by taking major amounts of costs out, and actually have improved their margins," Engelhart said. He doesn't expect significant consolidation activities to begin for at least a few more years.
"But as managed care continues to impact length of stay, hospitals will be faced with much lower average daily census," he added. "That will have an effect on financial results, which will present a more compelling argument for them to consolidate."
"Low profitability" hospitals will be the first group to consolidate or close, Engelhart predicted. A hospital that has a profit margin lower than the 25th percentile profit margin for all hospitals is considered by HCIA to have low profitability. Conversely, a hospital is deemed to have "high profitability" if its margin exceeds the 75th percentile margin for all hospitals.
Sourcebook data show a widening gap in performance between hospitals with robust bottom lines and ones that are financially feeble. Low-profitability hospitals' median operating profit margin dropped to -2.58% in 1995 from -0.77% in the previous year. High-profitability hospitals, on the other hand, continued to improve, posting a median operating profit margin of 11.2% in 1995, up from 8.7% in 1994.
The question is whether low-profitability hospitals will remain attractive enough for consolidations to occur, he said.