For the second year in a row, Modern Healthcare's Hospital Systems Survey shows that multihospital operators have shored up the performance of their hospitals only to see losses on investments and other nonoperating factors wipe out those gains before they reached the bottom line.
For the 189 systems that provided figures for net patient revenue, net revenue, net operating income and net income for both 2002 and 2001, net operating income rose a robust 52.4% to nearly $8.7 billion, but net income for those same systems was up just 1.3%, to $5.3 billion. Net operating margin, defined as net operating income divided by net patient revenue, was up a full percentage point for these systems, to 3.8% from 2.8%, yet net margin (net income divided by net revenue) fell slightly to 2.1% from 2.3%. These figures exclude the U.S. Veterans Affairs Department healthcare system because the size, accounting methods and unique nature of the system might skew the results.
The discrepancy between operating results and the bottom line could be key to the hospital industry's efforts to increase their Medicare and Medicaid reimbursements. Lobbyists for the hospital industry argue that the bottom-line figures show that hospitals are stressed by a weak economy that is fueling a rise in uninsured patients and, at the same time, is forcing states to pare their Medicaid programs. Critics of increased federal reimbursements say the operating margins indicated by this survey and others suggest hospitals are being reimbursed fairly, and any financial distress they are experiencing stems from losses on investments that have nothing to do with Medicare.
Like its predecessors, Modern Healthcare's 27th annual systems survey is nonscientific. Approximately 300 surveys were sent out, with 198 systems providing at least partial figures. A handful of those receiving the survey said that they no longer qualified for the survey because of hospital sales, mergers or closures-organizations must own, lease or sponsor two or more acute-care or psychiatric hospitals to be eligible. Respondents were asked to provide information for their 2002 and 2001 fiscal years, which may not correspond to the calendar year. Fiscal years ending June 30 and Dec. 31 were the most prevalent.
The respondents included 103 secular not-for-profit systems, 32 Roman Catholic systems, 29 public systems, 22 non-Catholic religious systems and 12 investor-owned chains.
There were no changes in the identities of the largest systems. The VA hospital system was the largest, with net revenue of $25.1 billion, followed by Nashville-based HCA. Ascension Health, St. Louis, once again was the largest private not-for-profit system, ranked No. 4 in net revenue (See charts).
Poor investment returns and weak or lower Medicaid reimbursements have made it challenging to build the kind of net margins that hospital systems need to maintain themselves long term, say advocates of reimbursement increases.
They are calling for a host of increases. Some are aimed at specific parts of the hospital industry and others are designed to offset decreases in state funding of Medicaid reimbursements. More broadly, they seek a Medicare reimbursement increase that's at least equal to the rate of inflation for the federal government's fiscal 2004, which begins Oct. 1, 2003.
Weakness in the stock market during the past few years definitely has eroded the bottom line for many systems, says Lisa Martin, an analyst at Moody's Investors Service. "The average hospital has invested 50% in the equity markets," Martin says. "The equities have had several years of declining returns. Those lower returns will impact net income." Modern Healthcare first reported on the trend last year (Nov. 4, 2002, p. 34).
According to the survey results, operating margins for the 179 not-for-profit and government systems that provided figures for both years (excluding the VA system) rose to 1.9% in 2002 from 1.2% in 2001, while net margin fell, to 1.3% in 2002 from 1.7% in 2001. Investor-owned systems fattened their profit margins even more in 2002-the survey results indicate the 10 for-profit systems that publicly report their results sported a 11.1% operating margin for 2002, up from 9.2% in 2001; their net margins rose to 5.4% from 4.8% in 2001.
"Our systems are trapped in economic doldrums," says Richard Wade, spokesman for the American Hospital Association. "There is just not any predictability."
Workforce shortages and higher malpractice insurance premiums are driving up costs, he says. The stagnant economy and the increasing number of job layoffs in some communities also have played a role in shrinking net margins, he says. Those who are laid off often lose their health insurance along with their jobs, Wade says, so hospitals deal with more patients who can't pay their bills. Such forces also add pressure to operating margins. Another revenue drain are niche providers who, Wade contends, are "cherry-picking" the profitable patients and leaving Medicare, Medicaid and uninsured patients for community acute-care hospitals.
As a result of all these factors, hospitals will be more likely to collaborate with physicians and enter affiliations with other hospitals, Wade says. Joint ventures in providing services, such as opening new laboratories, will be more prevalent, he adds. "Doing it together makes more sense," he says. "It cuts costs, and there are more efficiencies. You are going to see hospitals finding other sources of revenue."
Critics of Medicare reimbursement increases do acknowledge that some targeted relief may be in order, but a broad-based increase in payments such as the ones providers won in 1999 and 2000 can't be justified and may end up hurting hospitals in the long run.
These critics-including Tom Scully, administrator of the Centers for Medicare and Medicaid Services, and the Medicare Payment Advisory Commission-contend that hospital margins have rebounded from the low levels brought on by both the strength of managed-care plans in the mid-1990s and the Medicare cuts in the Balanced Budget Act of 1997.
They argue for leaving Medicare reimbursement policy right where it is for fiscal 2004, with increases slightly less than the rate of inflation.
"The bottom line is everyone has investment portfolios, and when their investments go south, their returns go south," Scully says. "I'm sure that's what it is."
As the former head of the Federation of American Hospitals, which lobbies for the investor-owned sector of the industry, Scully says he understands the motivation to lobby for higher reimbursements, but for the good of their members, he says, the lobbies should resist the temptation. "The best thing to do about hospitals now is to leave them alone," he says-to neither cut nor increase Medicare reimbursements. A full-inflation reimbursement increase "would be a mistake," he says, the kind that would draw congressional action in a year or two if margins start looking too good, making it impossible to achieve the stability the industry seeks. "These roller-coaster rides are not good for anybody," Scully says.
A MedPAC report issued to Congress in March backs up Scully's contentions. For instance, a chart in the report shows that hospital margins reached their peak of the 1990s-6.1% in 1996 and 6% in 1997-just before Congress drastically slashed Medicare reimbursements with the Balanced Budget Act of 1997.
The report also suggests that Medicare payment rates are adequate for fiscal 2003 and that any changes for fiscal 2004 should be geared toward redistributing the payments to benefit some weaker hospitals, particularly those in rural areas. MedPAC recommends increasing Medicare inpatient rates by the inflation rate minus 0.4% and the Medicare outpatient rates by inflation minus 0.9%.
The report also states that consumers' move from HMOs to PPOs, which require much wider networks that include most or all providers in a given market, has weakened the bargaining power of health plans to the advantage of hospitals.
Providers not convinced
"What's striking to me," says Chip Kahn, president of the federation, commenting on Modern Healthcare's survey findings, "is that revenue was up, but the bottom line was pretty stable. It says to me that there are a lot of cost pressures." Operating margins, he says, still "are below what are optimal for this kind of industry, so I think we still have significant issues with payment by Medicare and other payers."
As for the much bigger margins earned by the for-profit sector compared with the not-for-profit and government sectors, Kahn says his members "have a proven track record in providing good care in an efficient, professional way. I think these margins reflect that."
The investor-owned figures could be swelled somewhat by Tenet Healthcare Corp., Santa Barbara, Calif., which has acknowledged that it was receiving a very high level of Medicare outlier payments that are supposed to reimburse hospitals for the sickest patients. Tenet's results for the first three months of 2003 already show the dramatic effects that its policy change toward outliers will have on this year's results, as outlier revenue fell to $18 million for the quarter from $197 million in the year-ago quarter (May 19, p. 10).
For the 30 Roman Catholic systems that responded to the survey and reported figures for both years, the overall operating margin increased to 1.7% from just under 0.9% in the previous year, but net margin fell to just under 1.2% from 1.3% in the year-earlier period, according to the survey results.
"The margin (at not-for-profits) is anemic at best," says the Rev. Michael Place, president and chief executive officer of the Catholic Health Association. "The ongoing challenges are the result of the continuing commitment of caring for the uninsured. These results reflect the same issues in the safety net study."
In a report released last year, the CHA maintained that private not-for-profit hospitals are providing care for the poor and uninsured at the risk of their own financial stability (Nov. 18, 2002, p. 8). Place has called on lawmakers to identify new funding for all not-for-profit hospitals.
The increasing costs of labor, technology and pharmaceuticals have made it more difficult for not-for-profits to increase their margins, Place says. Systems have concentrated on becoming more efficient, but there is "not much more we can do," he says.
The measures taken by the largest member of Place's association, Ascension Health, provide some perspective on what hospitals are doing to achieve better savings and boost margins. In fiscal 2002, ended June 30, Ascension reported earning $111 million on net revenue of $7.7 billion, for a net margin of 1.5%.
For the nine months ended March 31, Ascension reported earning $106 million on $6.6 billion in net revenue, for a net margin of 1.6%.
Tony Speranzo, the system's chief financial officer, says, "our operating margins are being challenged. That is causing us to do a number of things to deal with some of the cost pressures." The system is employing best-practice benchmarking for internal operations and improving supply chain initiatives where a global catalog of supplies has been established, saving the system "tens of millions," he says.
Despite the pressures, Ascension acquired Carondelet Health System late last year, adding its eight acute-care hospitals for a total of 67. Ascension did not shell out any cash in the deal but agreed to take on $250 million in Carondelet debt.
The complete ranking of all respondents to Modern Healthcare's 2003 Hospital Systems Survey, along with contact information and additional charts, can be found in the Surveys/Lists/Data section
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