Maybe not-for-profit hospitals should purchase shares in their for-profit brethren.
The latest hospital systems survey by Modern Healthcare shows that not-for-profit systems reported improved operating results for fiscal 2001, but losses on investments seem to have kept the improvement from reaching the bottom line. Meanwhile, for-profit hospital chains posted the kind of expanded profit margins that have made them a favorite on Wall Street.
Regardless of their ownership, systems collectively posted an operating profit of 3.16% in 2001, a modest increase from 2000, when the margin was 2.27%, according to the results of Modern Healthcare's 26th annual Hospital Systems Survey. Operating margins are calculated by dividing operating income by net patient revenue.
After losing money on operations in 1999 and squeaking out a 1.07% operating margin in 2000, the not-for-profit sector improved its performance slightly to collectively post a 1.89% operating margin in 2001 for the 188 not-for-profit hospital systems that provided figures for both years. For the same 188 systems, net margin was 1.53% in 2001, down from 2.11% in 2000. Net margin equals net income divided by net revenue, so it adds revenue and income or losses from nonclinical businesses and investments to the operating figures.
Fitch Ratings noted the reversal of investment gains in its "2002 Nonprofit Hospital and Health Systems Outlook." The New York-based credit-rating agency wrote that many hospitals have relied on investment gains to cover up operating losses since 1998. "However, Fitch believes that the safety net is now gone," the report states. "Fitch expects the unpredictable equity markets will also force providers to consider a change in investment policy and move away from equity investments and more toward conservative investments such as fixed income and cash."
"The negative (stock) market has had a significant impact," says the Rev. Michael Place, president and chief executive officer of the Catholic Health Association. "In previous years, the income on reserves was able to counterbalance the negative trends in operations. As long as that (market slump) continues, that will be a challenge for Catholic healthcare" and other not-for-profits.
A total of 212 systems-defined as organizations that own, lease or sponsor two or more acute-care or psychiatric hospitals-responded to this year's survey, out of 315 surveys that were mailed. The respondents included 14 for-profit companies, 32 Roman Catholic systems, 10 with religious affiliations other than Catholic, 19 public systems and 137 private, not-for-profit systems. The nonscientific surveys asked respondents to provide information for their 2001 and 2000 fiscal years. These periods may vary, with those ending Dec. 31 and June 30 being two of the most-used fiscal years.
American Hospital Association spokesman Richard Wade cautions that the results shouldn't mask a difficult operating environment.
"Even though you may see a slight improvement in margins for these systems, the economic challenges they're facing to keep providing a level of services for the community is enormous," Wade says. "You've got a whole confluence of pressures to invest in new information and medical technologies, and many hospitals are also looking at plant replacement. How do you do that on less than a 2% operating margin?" Wade says operating margins from 2% to 5% are considered solid, but hospitals hovering around the 2% mark are just "keeping their heads above water. You need to be in excess of 5% if you want to be healthy enough to go to the bond markets."
Wade adds that continued Medicare cuts, rising medical liability costs and competition from niche hospitals will all provide formidable challenges for not-for-profits in the coming year, as will the increasing number of uninsured people that is expected unless the economy picks up speed.
The 10 for-profit chains that provided comparable figures for both years posted an operating margin of 10.14%, up from 8.61% in 2000. The chains' net margin, which includes taxes and one-time charges, was 5.48%, up from 2.34% in the previous year. Triad Hospitals, Dallas, provided figures for both years, but the company's April 2001 acquisition of Quorum Health Group, Brentwood, Tenn., skewed any comparison of 2001's margins to 2000's figures.
Chip Kahn, president of the Federation of American Hospitals, the for-profits' lobbying arm, acknowledges that the investor-owned companies are outpacing the rest of the industry. "But by anybody's definition, their margins are fair and reasonable," he says. Kahn says the improvements reflect a modest recovery from the hits most hospitals have taken from the rise of managed care in the early 1990s and the Medicare reductions in the Balanced Budget Act of 1997. "I think we're now at the other end of the tunnel," he says. "I think the investor-owned hospitals may have gotten to the other side of the tunnel more quickly."
The investor-owned chains have greater access to capital, Kahn says, leading to greater investment in high-revenue, high-acuity services. He also contends that the for-profit managers have a tremendous amount of experience at honing operations to make them financially sound. Place also thinks the for-profits benefit from being more selective about the neighborhoods they serve and the services they offer than the not-for-profit sector, which includes many safety-net hospitals.
The U.S. Veterans Affairs Department healthcare system, with $24.4 billion in net patient revenue, continues its position as the nation's largest system responding to the survey when ranked according to net patient revenue. The VA owns and operates 163 hospitals with 19,931 staffed acute-care beds. HCA, Nashville, retains its position as the largest for-profit system and the second-largest system overall, with net patient revenue just under $18 billion. The company owned or operated 184 hospitals at the end of 2001. Ascension Health, St. Louis, remains the largest not-for-profit system and the fourth-largest system in the country, with $6.5 billion in net patient revenue, a 10.3% increase from net patient revenue of $5.8 billion in 2000.
Focus on operations
Some of the improvement in operating income can be chalked up to the pure fear that managed care and the balanced-budget law put in the hearts and minds of hospital administrators. Fear led to the motivation to engage in painful cost-cutting and a sober analysis of which services and assets are core and which can be safely jettisoned.
Catholic Health Initiatives, which owned, leased or operated 64 acute-care hospitals in fiscal 2001, has largely completed its cost-cutting phase, says Jerry Judd, the system's vice president of treasury services. For its fiscal 2001, which ended June 30, CHI reported earning $167.2 million on $5.7 billion in total revenue, compared with earnings of $96.5 million on $5.6 billion in total revenue in 2000. The improvement came on operations, where earnings rose to $76 million in fiscal 2001 from $10.4 million the previous year.
The Denver-based system has sharply cut the number of physicians it employs and has implemented myriad small economies, market by market, Judd says. CHI recently completed an evaluation of the real estate it owns, and its next step will be to sell properties that aren't essential, Judd says. "That fits into that general theme about getting back to basics," he says.
CHI already has decided to sell its four-hospital St. Joseph Healthcare, Albuquerque, to for-profit Ardent Health Services, Nashville, because CHI does not want to invest the $35 million to $50 million that the New Mexico system requires (March 25, p. 12). Ardent and CHI have reached a definitive agreement for Ardent to pay $79 million for the hospitals (May 27, p. 4).
Judd says operating margins will have to continue to improve for the system to meet its capital needs. He expects CHI's biggest question in the coming years will be picking and choosing where to spend. "The `free lunch' of double-digit investment returns just isn't there," Judd says. "If you're building cash, it isn't off investments. It's off operating results."
Against the grain
Systems seem to be interested in behavioral health services when it comes to specialty clinical offerings, according to this year's survey results, but industry observers contend that many providers are converting psychiatric beds to higher-margin medical-surgical beds. This year's surveyed systems reported owning, leasing or sponsoring 139 freestanding psychiatric hospitals in 2001, a 2.9% increase from 135 in 2000. The systems reported staffing 12,508 beds in those hospitals, up 4.5% from 11,965 beds in 2000.
The New York State Office of Mental Health was not included in the psychiatric services category of this year's survey because it declined to disclose its net revenue and related financial information. If the provider had given its financials, it would have repeated its position as the leader of behavioral health services. The system reported owning 28 psychiatric hospitals in 2000 and 2001, even with a 5.8% decrease in the number of beds from 6,006 in 2000 to 5,658 in 2001.
Although respondents to Modern Healthcare's survey indicate an increase in psychiatric beds and facilities, analysts say the trend since the mid-1990s has been toward consolidation and fewer beds. "There were too many beds, high costs and not enough reimbursement," says Gary Lang, a behavioral healthcare consultant and partner with Fairfax, Va.-based Arista Associates.
Lang says community hospitals, in particular, are facing tough decisions when it comes to determining whether to maintain or reduce behavioral health services in their markets. On one hand, increased demand is putting pressure on community hospitals to provide care, yet "bottom of the barrel" margins make behavioral health services among the first to be cut as systems look for ways to expand, often by increasing intensive-care beds, Lang says.
Meanwhile, hospital systems are bucking the overall trend in assisted living, offering more facilities and beds even as more for-profit assisted-living companies file for bankruptcy.
For the 64 hospital and health systems that provided figures for the number of residents and facilities for both years, assisted-living locations increased nearly 10% to 168 facilities in 2001, up from 153 in 2000. Beds increased 9% to 10,400.
UPMC Health System, Pittsburgh, reported owning and operating the most assisted-living beds-1,524-a 24% increase over the 1,229 it operated in 2000, but Seattle-based Providence Health System operated the most facilities with 13 locations.
Assisted-living advocates contend that the industry expanded too quickly, and many of the private providers have faced financial struggles. With an oversupply of beds, demand will eventually catch up, but not for a couple of years, they say.
"After so many years, (assisted living) is still trying to define itself," says Conchy Bretos, Florida's former secretary of elder affairs who is CEO of Miami-based MIA Consulting Group, which caters to the elder-care market. "There are 28 definitions of assisted living, and each state has different regulations. Kentucky doesn't regulate it at all, whereas Florida, New Jersey, Texas, Oregon and New York are the most regulated. Every time you go into a state and you want to open an assisted-living facility, you're starting from scratch."