At first blush, the results of Modern Healthcare's annual Hospital Systems Survey seem to bear out what hospital lobbyists have been saying-it's getting tougher to make money on operations.
For the 177 multihospital systems that provided figures for net patient revenue, net revenue, net operating income and net income for both fiscal 2003 and 2002, net operating margin (equal to net operating income divided by net patient revenue) fell sharply, to just under 2.8% in 2003 from 3.9% in 2002. The bottom-line figures still improved-a 2.9% net margin in 2003, up from 2.1% (net margin equals net income divided by net revenue)-but the operating performance could be seen as troubling.
For one respondent to the survey, the differences between 2002 and 2003 are extremely troubling. Tenet Healthcare Corp., which is the third-largest system to respond in both revenue and hospitals owned, had such a dramatic change in its results from year to year that it makes sense to look at the numbers without Tenet.
Those revised numbers paint a much different picture, as different as modern art is from the old masters. Remove Tenet from the calculations, and the remaining 176 systems saw their net operating margins climb to 3.6% in 2003 from 3.3% in 2002. The net margin, buoyed by a stock market that saw solid gains in 2003, was also about 3.6%, nearly double 2002's 1.9% margin.
Tenet recorded a swing of nearly $3.2 billion in net operating income, to an operating loss of $1.56 billion in 2003, and a $2.29 billion swing, to a loss of $1.48 billion, on overall results. Tenet beat the expectations of analysts for the first quarter of 2004, breaking even before charges related to its restructuring were included but the company cautioned that this year will still be a difficult one for the company (May 3, p. 14).
These 176 systems earned a combined net income of $8.7 billion in their fiscal 2003, more than double 2002's combined net income of $4.17 billion. Operating income climbed 22.2% to $7.92 billion. Net revenue for the 176 systems rose 9.7% to $240.45 billion, and net patient revenue was up 9.8% to $218.05 billion.View the rankings, along with web-exclusive charts.
All of the summary figures above exclude the U.S. Veterans Affairs Department because the size, accounting methods and unique nature of the veterans system might skew the results.
Topping the charts
In terms of number of hospitals, Nashville-based HCA remains at the top of the heap, with 182 owned acute-care hospitals (the company also operates seven hospitals via 50-50 joint ventures), followed by the Veterans Affairs system with 160. Ranked by net patient revenue, however, Veterans Affairs is the biggest system, with $25.78 billion. HCA remained second with $21.81 billion, but it closed the gap when it closed its acquisition of the former Health Midwest system (Oct. 21, 2002, p. 8) in April 2003.
Tenet remained third on both lists, but the company's plans to divest more than 30 hospitals this year mean that it could slip in next year's rankings in both categories. The divestitures would leave Tenet and fellow investor-owned chain Community Health Systems, Brentwood, Tenn., close to even, depending on acquisition activity by Community, the fourth-largest system in terms of hospitals owned. Tenet is opening two hospitals this quarter.
Ascension Health, St. Louis, is the largest not-for-profit system based on revenue and No. 4 overall in the revenue rankings. Even with Tenet's divestitures, it would be difficult for Ascension to pull even or take the third spot unless it makes a major deal. When Tenet reported earnings for the first quarter ended March 31, its revenue on the hospitals it plans to keep was just under $2.7 billion, which annualizes to $10.8 billion. Ascension, meanwhile, would have to increase its revenue more than 25% to reach that level in fiscal 2004.
The systems survey is nonscientific. A total of 182 systems responded to the survey by providing at least partial figures, down from 198 systems a year ago. This year's respondents included 106 secular not-for-profit systems, 27 Roman Catholic systems, 23 systems with other religious affiliations, 16 government-owned systems and 10 for-profit or investor-owned systems. To qualify for the survey, organizations must own, lease or sponsor two or more acute-care or psychiatric hospitals. Respondents were asked to provide information for their 2003 and 2002 fiscal years, which may not correspond to the calendar years. Fiscal years ended Dec. 31 were the most common, with 72 respondents, followed by June 30 (52 systems) and Sept. 30 (47 systems).
On the margin
Modern Healthcare's 28th annual systems survey isn't the only review to suggest that hospital margins are strengthening.
The American Hospital Association's annual statistical report, Hospital Statistics 2004, showed that the aggregate hospital margin increased in fiscal 2002, the first such increase since 1996 (Jan. 5, p. 6). The AHA's report confirms the strong improvement in operating income for systems that was documented by the 2003 systems survey (June 2, 2003, p. 26).
The Medicare Payment Advisory Commission reported in March that Medicare margins overall and on inpatient cases should stabilize this year after two years of declines. MedPAC contends that "the lower margins in 2001 and 2002 were caused primarily by unusually large increases in hospitals' per unit costs," but the commission doesn't believe that those increases continued in 2003 or into this year.
MedPAC also noted in its report that efforts by the CMS to limit Medicare outlier payments may not pan out the way the agency intended. The report said it is difficult for the CMS to predict what level to set the outlier loss threshold (or minimum amount of loss on a case for a hospital before the extra outlier payments kick in) to limit payments. MedPAC also said it wasn't sure whether other hospital payment increases included in last year's Medicare modernization act would offset the outlier effects.
Other anecdotal evidence also suggests the sky isn't falling. The AHA reported that the number of general acute-care hospitals in the U.S. grew by 19 in 2002, the first time since at least 1975 that the number went up (Jan. 12, p. 6). Hospital construction of all types totaled $8.9 billion in 2002, up more than 50% from 2000, according to McGraw-Hill Construction Analytics and Consulting.
Carmela Coyle, senior vice president for policy at the AHA, contends that no one should see these margin figures as particularly rosy. Looking at the operating margins, Coyle says, "Things have stabilized from '02 to '03, but still at levels that create some real concerns in terms of hospitals' ability to reinvest." She adds, "Operating margins in the 2% to 3% range really don't allow them the kind of funding that they may need," whether for technology or replacement of bricks and mortar.
Coyle says she expects 2004 to be another year of relative stability. The Medicare modernization act will help a lot of hospitals improve their margins and the stock market, so far, has at least maintained the gains of 2003, she says.
While Medicare reimbursements have improved, on the whole, for 2004, some of those increases could be offset by cuts in Medicaid budgets in some states, Coyle says. "It's what makes this very difficult to look at in the aggregate," she says. "There's lots of variation among systems."
Rising bad-debt expense also could weigh on margins in 2004, Coyle says. She sees the issue heating up for hospitals in 2004, more from an increasing number of patients who are under-insured rather than completely uninsured. "Basically, as employers try to deal with insurance companies raising premiums to higher and higher levels ... one of the things that we've seen employers doing is increase copays and deductibles," she says. When she talks with hospital executives, Coyle says, she is hearing more concerns about rising bad-debt expense.
Rising bad-debt expense has squeezed margins for investor-owned hospital chains for nearly a year now, yet investors keep pouring money into new for-profit hospital companies (March 1, p. 40). Even accounting for Tenet's troubles, the investor-owned hospital chains still showed lower operating margins.
Nancy Weaver, a healthcare stock analyst for investment bank Stephens, says bad-debt expense has had the biggest impact on margins in the investor-owned sector during the past 12 months, driven mostly by the rising numbers of uninsured patients. For the four publicly traded urban hospital chains, bad-debt expense increased to 9.7% of revenue for 2003, compared with 7.2% for 2002. Bad-debt costs at the four chains-HCA, Tenet, Triad Hospitals and Universal Health Services-totaled $4.12 billion in 2003, or 43% more than in 2002.
Weaver also says that the changing nature of employee-sponsored health insurance will have a bigger impact on bad-debt expense going forward. "I think the hardest thing about bad-debt expense right now, looking out two or three years, is that we're really seeing some fundamental changes in the way healthcare is paid for," Weaver says. "Big companies are pushing the cost onto employees."
As a result of that shift, Weaver says even an improving job climate that strengthens during 2004 won't necessarily erase a lot of that bad debt.
On the cost side, hospitals have done a good job of reining in labor costs, thanks in part to the weak job market of the past two or three years, Weaver says. One troublesome sign so far this year is an increase in supply expense, driven primarily by more expensive implants being used in cardiovascular and, to a lesser extent, orthopedic surgeries, she adds.
Low volume in the first half of 2003 was the other factor that limited margins, but the first-quarter 2004 results for investor-owned hospital chains indicated that patient volume was picking up, she says. Medicare, especially for rural hospitals, and commercial payers have been solid contributors to revenue, despite the predicted slowdown in commercial reimbursements.
Looking ahead, Weaver sees early 2005 as a crucial time to watch for signs of a continued shift of healthcare costs onto consumers, because she believes that shift is just beginning.View the rankings, along with web-exclusive charts.