Reports from the three credit-rating agencies show that not-for-profit hospital operating margins ended a three-year free-fall in 2000, but that piece of good news was overshadowed by the agencies' dim outlooks for continued improvement. Moreover, the reports were drafted before the Sept. 11 terrorist attacks, and a rapidly worsening economy could add to the industry's problems, analysts say.
The agencies' median values are based on audited financial results of hospitals whose creditworthiness is rated for investors. Although they aren't comprehensive and don't always agree with each other, the rating agencies offer some of the timeliest and most reliable snapshots of industry finances.
* According to Standard & Poor's, which rates more than 500 hospitals and healthcare systems, the median operating margins for high-quality and upper-medium-quality hospital credits increased to 1.6% and 1.3%, respectively, compared with 1.3% and 1% in the previous year. Medium-grade credits had a median operating margin of 0.5%, compared with 0.4% in the previous year.
* Fitch, which includes 153 hospitals and systems in its medians reports, says operating margins were essentially flat in 2000, with slight declines from the previous year in some rating categories and slight improvements in others.
* Moody's Investors Service found operating margins improved slightly overall, while total margins slipped (See chart). The 50 biggest hospitals and single-state systems saw an improvement in their operating margins, to a negative 0.4% from a negative 1.4% in 1999, according to Moody's. Meanwhile, the agency found that 41.8% of hospitals and healthcare systems had operating deficits last year, compared with 40.6% a year earlier. In 1996 that figure was only about 14%.
Analysts noted modest gains in some key financial indicators, such as cash flow, debt-service coverage and liquidity. Hospitals reversed negative trends by divesting unprofitable businesses, raising prices, increasing volume and achieving efficiencies from mergers completed a few years earlier, analysts say.
On another positive note, the Balanced Budget Act of 1997, a five-year plan to reduce Medicare costs, is in its final year. Some provisions of the law that hammered hospital balance sheets are set to expire on Sept. 30, 2002.
But with labor costs edging higher and the economy in a tailspin, analysts say they don't expect margins to improve significantly this year, if at all. That's not encouraging, because recent profitability levels fall far short of what's considered adequate for growth. Many hospitals have had a tough time translating higher demand for services into profits because of a lack of skilled labor and adequate facilities.
Although healthcare is considered to be resistant to recession, the economic repercussions of the terrorist attacks have heightened concerns about potential declines in investment income and philanthropy. Large hospitals and healthcare systems and those in the highest rating categories tend to be most reliant on those sources of revenue. One key revenue source, Medicaid, could be targeted for cuts as state coffers dry up.
Another lingering question is whether insurance companies can repeat last year's double-digit premium increases, some of which were passed along to hospitals. If employers shift costs to workers through higher deductibles and copayments, hospitals could lose revenue if they don't improve collection efforts, says Martin Arrick, a director in public finance at S&P.
"We're still seeing a lot of negative credit trends," notes Liz Sweeney, another S&P analyst.
Despite the leveling off of performance, downgrading has continued full throttle this year. Analysts sometimes wait for years of poorer results before changing a rating. Also, some hospitals that might have been upgraded weakened their balance sheets by issuing new debt.
Many hospitals have seen their outlooks revised this year to stable from negative, signaling that fewer will be downgraded in the coming months. In its outlook, Moody's expects the pace of rating changes to slow in the next six to 12 months, although ratings generally won't improve. So far this year, Moody's has issued about three downgrades for every upgrade, compared with 4.7 downgrades for every upgrade in 2000.
In the current environment, that can be called good news.