Southeast Michigan health systems reverse trends, reap profits

Southeast Michigan health systems last year battled double-digit increases in drug prices and historically low rate increases from commercial and government payers to post the highest profit margins in several years, according to top system executives.

After several years of continued Medicare reimbursement cuts and financial penalties to help pay for the Affordable Care Act that have dampened profitability, the five systems in metro Detroit that reported 2015 financial data to Crain's Detroit Business positively rebounded by treating more patients and continuing to hold expenses down.

Aiding their efforts to improve profit margins have been double-digit declines in uncompensated care, which includes charity care and bad debt, due primarily to Medicaid and private health insurance expansion that added more than 1 million people in Michigan to insurance rolls.

It's unclear if the decline in bad debt will continue. Last year was a reversal of previous trends of increasing unpaid patient bill, and some hospital executives said they expect bad debt to increase again as more people are covered by high-deductible health plans, which put more responsibility for paying on patients.

Last week, Crain's reported record average 2015 profit margins to 3.9 percent for Michigan's 14 Medicaid HMOs, which also was primarily stimulated by Healthy Michigan expansion of 619,000 new enrollees. Most hospital-based systems also experienced modest gains in patient volume from the Medicaid expansion and from more acutely ill patients in clinical service lines such as neurology, orthopedics and cardiac care.

For example, Beaumont Health, a newly formed eight-hospital system based in Southfield, enjoyed an operating income increase of 13.7 percent to $140.7 million in fiscal year 2015 ended Dec. 31. Beaumont's operating margin rose to 3.4 percent from 3.1 percent in 2014.

"We met (our budget) plan, plus a little better than that," said John Fox, CEO of Beaumont Health. "The reality is if you are in health care today, because of the need to replace building and equipment and new technology, you want to (generate margins of) 4 percent or greater."

Detroit-based Henry Ford Health System, which recently added Jackson-based Allegiance Health as its sixth hospital, recorded a 303 percent increase in operating income to $111.9 million for fiscal 2015 ending Dec. 31. Henry Ford's operating margin rose to 2.2 percent in 2015 from 0.5 percent the previous year.

"2015 was a good year for Henry Ford," said Edward Chadwick, Henry Ford's CFO. "We had growth in revenue; on the provider and plan side, we touched more patients."

Driving Henry Ford's 7 percent revenue growth to nearly $5.1 billion was its outpatient volume, which jumped by 5 percent compared with 1.1 percent for inpatient admissions, Chadwick said.

"We feel very good about that positive progress," Chadwick said.

For the first six months of fiscal 2016 ending Dec. 31, St. John Providence Health System, a five-hospital system based in Warren, improved its operating income 35 percent to $48.3 million. St. John's operating margin increased to 4.5 percent from 3 percent in 2014.

"Generally the year so far at the halfway point has been going relatively good," said Pat McGuire, St. John's CFO. "Volumes have been pretty moderate, and we are taking a lot of steps to try and get ready for more value-based reimbursement."

During the first six months, St. John's revenue jumped 11 percent, to $1.1 billion, while expenses grew 5 percent, to $1 billion.

"We are working on (reducing inpatient) readmissions, and population health (management) is keeping people as well (and out of the hospital) as possible," McGuire said.

During its first six months of fiscal 2016 ending March 31, McLaren Healthcare Corp., an 11-hospital system based in Flint, recorded a 115 percent increase in operating income to $65.3 million from $30.3 million. McLaren's operating margin rose to 3.6 percent from 1.8 percent in the prior half-year period.

"We began to see significant improvements last year and it carried over to this year," said David Mazurkiewicz, McLaren's CFO. "We have a substantial effort underway to manage expenses, and economies of scale have helped."

Mazurkiewicz said four McLaren subsidiaries did especially well, two of which are recent additions.

"Karmanos (Cancer Institute) and Port Huron (hospitals) showed significant improvement over the previous year. They are now getting the benefits of joining the system," he said, adding that hospitals in Lansing and Macomb also had above-average performances.

McLaren's bad debt and charity care dropped by 15 percent, to $54 million, for the first six months of 2016 from $63 million the same period of 2015.

"That has been a plus with Healthy Michigan," Mazurkiewicz said. "The sequestration cuts have not gone away, and Medicare continues to ratchet down reimbursements."

Despite drug costs increasing by 10 percent, McLaren was able to post record operating margins because it held expense increases per patient discharge flat, Mazurkiewicz said.

Two other health systems in Southeast Michigan — Ann Arbor-based St. Joseph Mercy Health System and for-profit Detroit Medical Center— did not report financial data to Crain's. Both are affiliated with larger health companies that did publicly report financial data.

St. Joseph Mercy is part of Novi-based Trinity Health, a Catholic system with 90 hospitals nationally, including eight in Michigan. For the first six months of fiscal 2016 ending Dec. 31, Trinity generated $38.2 million in operating profits for a 0.5 percent margin.

Trinity's operating income declined nearly five-fold from 2014 from $227.9 million for a 3.6 percent margin primarily because of several hospital acquisitions in Connecticut and New York and ongoing investments in population health initiatives, according to financial reports.

DMC is owned by Dallas-based Tenet Healthcare Corp., which operates 84 for-profit hospitals nationally. Tenet reported a 19 percent increase in operating income to $1.1 billion for fiscal 2015 ending Dec. 31. Tenet's operating margin increased to 5.9 percent from 5.6 percent the prior year.

After accounting for taxes, other charges and litigation costs, however, Tenet lost $140 million. As a result, Tenet was removed from Standard and Poor's 500, a blue-chip stock index. Tenet will move to S&P MidCap 400.

DMC officials have told Crain's previously that the seven-hospital system is ahead of projections.

Michigan's health system finances reflect national trends, according to Moody's Investors Service in a recent report.

Hospitals are improving operating profit margins through rising patient volume, a reduction of bad debt and charity care, and ongoing quality and efficiency initiatives begun during the recession.

Because of the improvement, Moody's upgraded the credit outlook for nonprofit hospitals to stable from negative for the first time in six years.

Moody's warned that rising profit margins are temporary. Many hospitals are heavily investing in building ambulatory care centers, acquiring physician practices and spending on population management and information technology systems.

As Healthy Michigan Medicaid expansion has been very good for health plans, hospitals also have reaped financial benefits.

Henry Ford's bad debt dropped 35 percent to $75.9 million last year from $116.2 million in 2014, and charity care at cost dropped to $24 million last year from $48.1 million.

"The increase in coverage through subsidized exchanges and Medicaid expansion clearly gave people access to coverage, (many of whom) did not have coverage before," Chadwick said. "No question that helped."

But Chadwick said he expects bad debt to increase over the next several years as more people are selecting high-deductible plans with higher out-of-pocket costs, he said.

Beaumont's charity care dropped 39 percent to $69 million last year from $114 million in 2014. Bad debt declined 23 percent to $119 million in 2015 from $154 million the previous year.

"It is a short-term blip," said Fox. "Medicaid expansion happened, and now it is over. We have 600,000 with it, and the effects have rolled through. The ongoing trends of costs being shifted to employee and patients will continue with higher deductibles."

While bad debt dropped somewhat for St. John to $60 million last year from $62 million in 2014, charity care dropped 42 percent to $17.8 million last year from $30.7 million in 2014.

"Healthy Michigan has been good for hospitals," said McGuire, adding that the revenue gains also must be balanced with Medicare payment cuts the past four years to help pay for Obamacare.

"Medicaid is not a great payer, but it is good for hospitals and good for the beneficiary," he said.

McGuire said the provision of charity care has reached its low point and is expected to rise as an improving economy lifts more people's incomes past Medicaid limits.

"Bad debt will increase because there is more cost shifting from the employer to the employee who will be responsible for those bills," he said.

Given that Beaumont is still integrating the former Oakwood and Botsford hospitals, Fox said he is especially heartened that patient volumes are on the upswing.

"Whenever you have a big merger, you always wonder how the market will respond," Fox said. "Sometimes you can hit air pockets and volume dips. We are going in the opposite direction."

Fox said an 8 percent increase in emergency visits drove inpatient volume up by 2 percent. Some hospitals over the past several years, including Beaumont, had experienced inpatient declines.

Despite larger numbers of patients, Fox said, overall reimbursement rate increases from payers have averaged less than 2 percent.

While revenue increased 3.8 percent, Beaumont's total expenses rose 4.5 percent to $3.8 billion in 2015, despite economies of scale savings through the merger.

Fox said one factor driving higher expenses at Beaumont has been pharmaceutical costs that have increased by about 9 percent.

Drug price increases are due to several factors, experts said. Mergers and acquisitions of generic drug companies and takeovers by venture capital companies have stimulated price increases.

For example, prices of such injectable heart medications as Nitropress and Isuprel doubled after Canadian pharmaceutical giant Valeant Pharmaceuticals International Inc. acquired the parent companies.

Despite being part of the nation's largest nonprofit system, St. Louis-based Ascension Health, St. John hospitals have felt the pinch of rising supply and drug costs, McGuire said.

McGuire said average pharmacy costs are up 13 percent, which reflects pricing increases but also rising patient volumes.

Also driving expense increases at Beaumont, Henry Ford and St. John were one-time unusual charges.

Beaumont's expense increases were primarily due to one-time charges, which included $20 million merger costs and $56 million in non-operating losses. Those non-operating losses included $46 million in debt extinguishment from bond refinancing and $12 million in investment income losses.

Beaumont also took asset impairment charges of $52 million. A routine audit of holdings for its newly merged system resulted in major non-cash write-downs, Fox said.

"Whenever you have assets, you need to periodically review them to make sure carrying value is not in excess of fair market value," said Fox.

After charges, net income dropped to $10 million in 2015 from $182.6 million in 2014.

Because Henry Ford's HAP Midwest lost a major Medicaid contract in Southeast Michigan, the system was forced to take a $37 million write-down, Chadwick said.

Going forward in 2016, Chadwick said, the additions of Allegiance and Flint-based HealthPlus of Michigan will add more than $500 million in revenue to Henry Ford's coffers.

For St. John, investment income losses during the second half of 2015 of $48 million resulted in a bottom line loss of $49,000. The same period of 2014, St. John had positive net income of $18.3 million.

"We try to earn about a 7 percent return on investment on the long run," McGuire said. "This was one of those periods where we were down."

"Southeast Michigan health systems reverse trends, reap profits" originally appeared in Crain's Detroit Business.