Hospitals that branch into other lines of business, including owning managed-care plans, face perils and rewards.
Over the past few years, a number of hospital owners have found that if you're not careful, you can lose your shirt in the HMO business without even trying.
But owning an HMO can insulate hospitals a bit in credit markets, even if the plan doesn't make a great deal of money.
Consider this fact: For the second consecutive year, Moody's Investors Service noted last August that median operating margins and operating cash flow margins for Aa-rated hospitals-which are more likely to own health plans-fell below those of A-rated hospitals. (Moody's Aa rating is better than its A rating.)
In 1997 Aa-rated hospitals had median operating margins of 3.4%, and A-rated hospitals had operating margins of 4.1%.
"We continue to believe the key contributing factor is that Aa-rated organizations are more likely to have integrated with other hospitals and nonhospital affiliates (such as health insurance plans), which often generate lower profit margins than the flagship hospital itself," Moody's says.
Many of those Aa-rated organizations experienced financial problems with their affiliates in 1997, which made their profit margins more variable, Moody's says. The lowest operating margin for an Aa-rated organization, for example, dropped precipitously to -5.4% in 1997 from -0.1% in 1996. A total of three Aa-rated hospitals lost money on operations in 1997, but only one lost money in 1996.
For the past several years, hospital profits have floated nicely upward, while managed-care profits have dropped like a stone. And generally, margins are lower for captive HMOs than for the hospitals that own them.
"It tends to be larger organizations that have HMOs," Moody's analyst Kay Sifferman says. "Therefore, on a consolidated basis, an organization with an HMO might be generating a lower overall profit margin," she says. For example, if the hospital is generating a 6% profit margin and the HMO is generating 1.5%, the organization's consolidated margin will be somewhere in between. "Compare that to an organization that has a 6% margin and is A-rated," she says.
Sifferman cites Catholic Health Initiatives, a 70-hospital system based in Denver, and Detroit-based Henry Ford Health System, which owns or affiliates with 13 hospitals, as examples.
CHI is rated Aa by Moody's. "Some of the numbers in that credit are not what you might expect," Sifferman says. That's mainly because of "diversification of cash flows. Other lines of business tend to bring cash flows down," she adds.
Standard & Poor's analyst Cynthia Keller mentions Henry Ford as the only health system whose rating might have been enhanced by its large, stable HMO, which brings in 50% of the system's revenues.
"An HMO could be beneficial if it provides a solid market presence or if it eliminates competitive pressures," Sifferman says. "But we have not upgraded anyone solely because they have an HMO. Nor have we downgraded anyone solely because they own an HMO."
Standard & Poor's doesn't expect the hospital-owned HMOs to be big rainmakers. "This is one more thing supporting the core hospital business," Keller said.
Jordan Melick, a credit analyst at Fitch IBCA in New York, agrees that hospitals and systems that own HMOs are likely to have lower overall profit margins.
If a hospital or system owns an HMO that is substantial and has market clout, it may help protect the system against the future compared with a system that must accept the terms of outside HMOs, he says.
"The fact that (the system is) integrated and has somewhat of a captive patient base gives it comfort," Melick says. "Furthermore, an entity that owns an HMO is likely to be a big system or a dominant player with multiple hospitals.
"If you look at our AA- vs. our AA, our AA- have higher ratios," Melick says. "That's because the AAs are larger systems in multiple states. They get positive credit for operating a more diversified system."
Melick cites Winston Salem, N.C.-based Novant Health as an example. AA-rated Novant owns a large health plan called Partners National Health Plan of North Carolina, which has 254,000 enrollees.
In calendar 1997 Novant posted revenues of $1.64 billion, of which Partners contributed $292 million.
Novant's overall system margin was 4.1%; Partners' margin was 2.9%. "So the plan contributed negatively to the system's total consolidated excess margin from a pure numerical point of view," he says.
"I would consider those margins beneath typical AA standards," Melick says. But the qualitative benefits, such as higher patient volume and more market clout, allowed Fitch IBCA to award the system a higher rating.
Standard & Poor's makes a related point in its Feb. 1 edition of CreditWeek Municipal. "Although the movement toward capitation appears to be moving forward slowly, any acceptance of insurance risk by hospitals and healthcare systems (including through health plan ownership) will continue to pressure profits."
In a way, that's OK with Sifferman. The goal, she says, is not to create profits through HMO ownership. "The goal is to create a service that benefits the community through low premiums. As a not-for-profit, that's part of the mission."
