Just as the introduction of a new weapon can change the face of warfare, the introduction of managed care and declining federal reimbursements has shifted the way in which hospital systems measure their success.
To keep pace with changes in healthcare, bond-rating agency Moody's Investors Service has changed the way it assesses credit profiles for not-for-profit health systems, according to a recent report from Moody's about its methodology for determining bond ratings for health systems.
While Moody's continues to use the same factors in its credit analyses, it now looks at the factors differently.
"In the past, we might have placed more emphasis on financial information," says Pamela Federbusch, senior vice president of Moody's public finance group. "Now, because markets are so volatile and things happen so quickly, you really have to look at your strategies for the future."
Federbusch says it all boils down to a system's ability to anticipate change and its willingness to deal with it.
"We're not stuck in the mud," Federbusch explains. "As markets change and people pursue different things, our analysis is going to change with the flow."
When issuing bond ratings for not-for-profit hospitals, Moody's continues to focus on six areas: management, medical staff, services, competition, financial performance and legal structure. But the emphasis has shifted in each of these categories.
For example, when looking at a healthcare system's management, Moody's used to give kudos for low turnover and overall stability. Now the rating agency looks beyond that to skill development, and a board of directors that can balance opportunities for expansion with financial prudence and anticipate risks associated with merger or acquisition deals.
Ken Rodgers, director of public finance for rating agency Standard & Poor's, agrees. S&P is reviewing mergers and acquisitions a lot more closely these days, he says.
"When we're analyzing new mergers or new acquisitions or new affiliations, we're being careful to make sure the parties presenting themselves really have coherent plans for integration of the organizations at the highest levels," he says. "We're a bit more skeptical about two big groups coming together (and) producing savings."
John Petersdorf, vice president of finance for Catholic Healthcare West, a 48-hospital system based in San Francisco, says the items the ratings agencies select for scrutiny are on target.
"We need adaptable managers who meet the latest pressures," he says. "We have managers who probably were not expert in capitation eight to 10 years ago, but they're expert now."
Petersdorf has reason to learn what's on the minds of bond rating experts, because both Moody's and Standard & Poor's downgraded his system last week.
At deadline, Moody's had downgraded the system to Baa1 from A2, affecting
$2 billion of CHW's outstanding debt. Standard & Poor's downgraded CHW to BBB+ from A on $600 million of debt.
Moody's recently put the system on its watchlist because of a possible loss of $225 million from operations this year.
"We expected it," Petersdorf says. "It's not something that one jumps for joy over, but it's a fact of doing business in this environment, and it just reinforces our need to improve results. It's nice to have an external source say, 'This is what's going on.' "
With medical staff, the emphasis is less on the type of physician practice maintained and more on the ways hospitals link the medical staff financially to the hospital.
"Moody's credit analysis incorporates the strengths and weaknesses of new strategies geared at motivating physicians to retain loyalty to a system and to service a provider's covered lives," Federbusch says in the report.
Physician strategies also have become more important as some hospitals have purchased physician practices to get a competitive edge, which has never materialized.
In looking at a hospital's service mix, Moody's seeks a broad range of services, because of the increasing need to attract managed-care contracts. Moody's also considers whether a hospital can shift its services to lower-cost outpatient facilities.
"The ability to use various settings to provide varying levels of care is viewed favorably in our current credit analysis," the report states.
Competition plays a greater role in credit assessments. And when defining competition, Moody's now considers many more angles than it did before.
In evaluating financial performance, more emphasis is placed on the cash flow generated by a system's core operations than cash on hand. Moody's used to focus more on how much cash a system had than where it came from.
"We view a provider's dependence on investment earnings income for cash flow less favorably than its ability to generate consistent or improving operating profits," the report states.
Rodgers, of Standard & Poor's, notes that a system that relies heavily on investment income rather than earnings from operations risks losing that cushion when the market turns.
Even though systems don't like to hear that they've been downgraded or otherwise negatively spotlighted by a bond rating agency, those that have been in that situation say that the analyses are based on relevant information and are accurate.
"They're a source of external benchmarking," says Petersdorf, who notes that the increasing downgrades throughout healthcare indicate that everyone is suffering some of the same revenues pressures.
Linda MacDonald, director of capital finance for Denver-based Catholic Health Initiatives, says the rating agencies serve an important purpose.
Moody's recently revised CHI's outlook downward to negative from stable on $1.6 billion of debt, because of an operating loss of $24.4 million that the company reported for the first eight months of its fiscal year, which ended June 30.
"I believe their assessment of our credit position at this current time is accurate," MacDonald says. "They might affirm what they're seeing others experiencing as well, so that's helpful. They actually can help you get a sense that the strategy that your health system is employing is something others find reasonable as well."