Outward bound

Multihospital systems delivered another year of strong revenue growth in 2011 as they deftly navigated a landscape of familiar financial roadblocks.

Hospitals, once again, faced the challenges of decreased volumes and increased reimbursement pressures. And not-for-profits and for-profits responded with a renewed focus on managing costs and maximizing revenue collection.

Yet the latest figures from Modern Healthcare's 36th annual Hospital Systems Survey show that systems pushed further to diversify services, particularly on the outpatient side, while re-investing more money in capital improvements. They also saw a boost from consolidation and government incentive awards such as meaningful-use payments for adopting electronic health records.

“We're seeing surprisingly good operating performance given that the operating environment continues to be challenging,” says Liz Sweeney, director of healthcare ratings at Standard & Poor's who follows the not-for-profit healthcare sector. “We've been surprised and impressed with how well hospitals continue to grow.”

Net income held flat from 2010 to 2011 at $23.5 billion, representing a 0.5% increase, for the 164 multihospital systems responding to this year's survey that provided the requisite information for both years. That's a far cry from last year's survey when net income soared by 117% between 2009 and 2010. Last year's results were based on responses from 199 systems.

In this year's survey, not-for-profit net income actually decreased over the year, declining by 1.7%. For-profits saw a net income gain of about 9% in 2011.

A total of 183 systems responded to this year's survey, but some organizations were excluded from rankings if they did not provide all the necessary financial information or did not meet the criteria for number of facilities specified in the data collection. The Veterans Affairs Department was excluded from the aggregate financial analysis.

Overall, participating systems reported a 7% rise in net patient revenue in 2011, with systems posting average patient revenue of nearly $2.4 billion. Total net revenue increased 6.1%, for an average of $2.6 billion per system. Net income for the year averaged $143.3 million.

Consolidation continued as an enduring theme in this year's survey, as systems grew larger. The systems (excluding the VA) reported that the total number of staffed acute-care hospitals they own, lease or sponsor rose 1.5% to 1,999, while the number of staffed acute-care beds increased 2.6% to 381,895.

The survey also shows that while the 10 largest for-profit health systems added 26 hospitals to their ranks, the 10 largest not-for-profit systems had a net loss of two hospitals.

Analysts who follow the sector say for-profit systems sought to gain scale through acquisitions while their not-for-profit peers tended to concentrate their cash on capital investments such as information technology. That's a repeat of what the healthcare sector underwent last year, says James LeBuhn, who heads the U.S. public finance group at Fitch Ratings. The flurry of mergers and acquisitions has only accelerated as the country continues to move forward with healthcare reforms, he says.

“I would even venture to say regardless of whether the Supreme Court rules to accept the (individual mandate) or to throw it out, that's a dynamic that's going to continue to hold in place,” says LeBuhn, who focuses on the not-for-profit sector.

Despite what may happen on the legislative front, Catherine Jacobson, president of not-for-profit Froedtert Health in Milwaukee, says providers must persevere: “Don't focus on what's going on in Washington,” she says. “Whatever's going to happen, you know that they are not going to pay us more.”

Not-for-profits saw total net revenue increase by 5.5%, to an average of $2.2 billion in 2011. About 92% of net revenue came from patient care, less than a 1 percentage-point increase compared with the previous year. For-profits saw a 9.5% increase in total net revenue, to an average of about $6.5 billion per system, and patient care accounted for 97% of net revenue in 2010, a 1 percentage-point rise compared with 2010.

The numbers also show that not-for-profits are continuing to grapple with what has been an unshakable trend in past system surveys by Modern Healthcare: With expenses last year averaging $2.4 billion, they are still spending more than they earn from patient care.

Sweeney notes that the systems continued to struggle against patient volumes that were “flat to down” in many markets, reimbursement pressure from government and commercial payers, and unrelenting growth in uncompensated care.

Indeed, systems in the ranking (excluding the VA) reported that they incurred an average of $339.4 million in uncompensated care in 2011, compared with $307.2 million the previous year—an increase of 10.5%.

But on the cost side, systems are doing a better job on revenue cycle and supply-chain management as well as containing labor expenses, Sweeney says.

“There's a broad-based focus on cost and revenue collection,” she says. “At least at nonprofits, we're seeing a slowdown in capital spending on bricks and mortar and an increase in spending in IT.”

Last year also saw a surge in outpatient services, as more systems added free-standing facilities in every category in the survey. Most notably, there was a 41.2% increase in the number of systems operating free-standing chest-pain clinics, a 34.5% rise in emergency services facilities and 32.4% increase in dialysis centers.

Compared with the previous year, fewer systems held acute-care hospitals in their portfolios—177 vs. 180, a 1.7% decrease—and the number of systems operating assisted-living facilities and continuing-care retirement communities fell 8.7% and 13.3%, respectively. Fewer systems also were operating skilled-nursing facilities (a 4.4% drop) and physician organizations (2.2%).

In contrast, more systems were operating long-term acute-care facilities (a 9.8% increase), free-standing psychiatric hospitals (a 2.3% increase) and rehabilitation facilities (a 2.2% rise).

Froedtert, which includes a 500-bed hospital in Milwaukee, saw a 10% increase in both net patient revenue and net revenue in 2011 and is an example of this shift. After seeing an increase in the demand for outpatient services, it decided to back off preliminary plans for a hospital southwest of the city. Froedtert will instead build the Moorland Reserve Health Center, a 135,000-square-foot multispecialty medical building in New Berlin, Wis., scheduled to open next year.

The decision comes in response to shifting demand toward outpatient service that hospital officials haven't seen in a decade, Jacobson says. Much of the decreased inpatient volumes are due to managing readmissions better: “We're doing exactly what we're supposed to do,” Jacobson says.

About half of last year's revenue at for-profit LifePoint Hospitals, Brentwood, Tenn., came from outpatient services. “We are actively involved in growing our outpatient business,” says William Carpenter, the system's chairman and CEO. “A lot of that is technology-driven. As there are improvements in technology, it allows us to provide services on an outpatient basis.”

Denise Warren, senior vice president and chief financial officer at Capella Healthcare, Franklin, Tenn., noted that her system has also seen a shift from inpatient services to outpatient, as evidenced by the growth in its adjusted admissions, an industry formula that takes into account both inpatient and outpatient activities.

“That, too, is an effort to control healthcare costs,” she says.

For-profit Capella last year spent $30 million on capital projects, and expects to spend at least that much in 2012. It added a diagnostic imaging center in Washington state and a free-standing cancer center in Oklahoma, built cardiac catheterization labs and upgraded women's-health facilities.

Mercy health system, Chesterfield, Mo., also diverted resources to outpatient care, doubling its number of free-standing clinics from 119 to 238 from 2010 to 2011. Mercy reported an 8% increase in net revenue in 2011 to $4.3 billion.

Shannon Sock, executive vice president of organizational effectiveness at Mercy, says spending on outpatient services will continue, but not just through brick-and-mortar expenses. Mercy has already invested by spending more on advancing telemedicine to expand those services.

It's more cost-efficient to spend on technology vs. construction, Sock says. After the initial investments in digital infrastructure, which are needed to comply with electronic health-record requirements to keep pace with upcoming changes for federal reimbursement, he says the cost of telemedicine has been dropping in recent years. Expansion in telemedicine would also free up staffing to concentrate on improving care delivery, Sock says. The bigger challenge is to ensure physicians are convinced and put in the best position to thrive with the new technology, he says.

“There are two camps: Those that are scrambling because they have not been investing to enable them to thrive” in an era of accountable care organizations and other healthcare reforms, and “those well-prepared that are actually going to grow and thrive in that environment,” Sock says.

Technology upgrades were also a key component of LifePoint's 2011 capital expenditures. Carpenter says that of the $220 million that LifePoint spent on capital projects, about $80 million went toward information technology, the majority of which was spent on achieving meaningful-use compliance.

The remainder helped fund investments in its current facilities, additions to its service lines and the system's new 100-bed Clark Regional Medical Center, Winchester, Ky., which opened its doors this year.

Publicly traded LifePoint is one of the systems that posted strong gains in its financial results last year; its net revenue increased 8.7% to $3.54 billion, while net operating income grew 7.2% to $536.2 million.

“We are focused on improving quality outcomes for our patients while at the same time becoming more efficient operators of our hospitals,” Carpenter says. “Those things are not mutually exclusive.”

The 13 for-profit systems included in the ranking outperformed their not-for-profit peers, but the chains in the survey included some of the largest players in the sector.

Together they saw a 10.4% increase in their net patient revenue, for an average of $6.3 billion in 2011. Net operating income increased 13.5%, with systems averaging $413.7 million.

Operating margins also improved to 6.7% compared with 6.4% in 2010.

Dean Diaz, a vice president and senior credit officer at Moody's Investors Service who follows for-profit healthcare systems, notes that on the key metric of “same-store” revenue growth, which compares facilities' performance against the prior year, investor-owned chains saw a revenue increase of about 4%. “It's a little bit lower (than previous years), but not to the point where it's of concern,” he says.

On the expense side, wages and salaries have increased, and systems have responded with cost-cutting measures in other areas, particularly on higher-cost technologies, he says.

At Capella, Warren points to the system's marketing and travel budgets as two examples of areas where it has been able to reduce costs. “We have to be extremely cautious in how we spend our dollars,” she says.

Yet one place where the investor-owned system has not cut back is in physician recruitment, bringing onboard 47 clinicians last year. Capella also boasts a 90% physician retention rate, which Warren says helps add stability to the company.

“Hospitals in general have been employing more physicians,” LifePoint's Carpenter says. “That has put pressure on the salary, wages and benefits line. We view the employment of those physicians as an investment in our hospitals.”

For-profit health systems have also been investing their cash in technology upgrades such as EHRs, and have seen significant acquisition activity, according to Diaz.

“The for-profits definitely hold a lot less cash than the not-for-profits,” he says. “I think scale and efficiency become an even more important factor in maintaining operating margins.”

Diaz cited not-for-profit health systems, physician groups and clinic sites as

prime targets.

Carpenter too noted that LifePoint has been focused on buying community hospitals in regions where it is already located. “The acquisition environment is very active,” he says. “There are a lot of opportunities for a company like LifePoint to acquire hospitals.”

He also highlighted the company's joint venture with Duke University Health System, Durham, N.C., which has already purchased three hospitals since it was formed last year. “We think it's representative of how care will be delivered in the future,” he says.

TAKEAWAY: While hospital systems overall saw smaller gains in net income for 2011, they continue to invest in capital projects, especially IT and outpatient services.