Rising labor costs, fluctuations in payer mix, and regulatory changes, among other issues, are pressuring many hospitals and health systems to reduce costs and increase revenue. Indeed, the 2017 Deloitte Survey of US Health System CEOs found that declining margins is one of the top issues keeping chief executives up at night.1
Current and projected margin challenges are considerable: Commercial health insurance payments as a percentage of hospital and health systems' total payments are projected to drop from 37 percent to 33 percent by 2024.2 The percentage of revenue from historically lower-margin Medicare payments is projected to increase from 35 percent to 40 percent of total payments.3 Labor costs are anticipated to continue rising due, in part, to patient volume growth from an aging and more chronically ill US population.4 Some future-state scenarios show that the combination of these trends could significantly reduce margins. A recent study from the Congressional Budget Office (CBO), for instance, suggests that absent productivity growth, between 51 percent and 60 percent of hospitals could have negative margins by 2025.5
To shed light on the main drivers of hospital operating expenses and revenue, we analyzed the financial performance (operating revenue and expenses per adjusted admission) of approximately 3,000 acute US hospitals between 2011 and 2015. We also conducted secondary research on the types of innovative technologies that hospitals are beginning to leverage to reduce costs and enhance revenue.
Our analysis turned up three key findings:
- Variation in hospital revenue and expense performance is large. Although, on average, margins increased from four percent in 2011 to 4.8 percent in 2015, roughly 30 percent of hospitals had negative operating margins each year. Almost half (45 percent) of hospitals with negative margins in 2011 were still negative in 2015.
- Hospitals might need to adopt new strategies, such as combining traditional workforce planning with predictive analytics, to improve efficiencies in labor costs and find alternatives to contract labor. Labor costs account for approximately 60 percent of hospital noncapital costs, and were consistently the largest driver of operating expenses between 2011 and 2015. After controlling for hospital and market characteristics—including admissions volume—we found that, on average, a 10 percent increase in salary and benefits is associated with a six percent increase in operating expenses. Contract labor drives expenses, as well. A 10 percent increase in contract labor is associated with a four percent increase in operating expenses, according to our analysis.
- To improve revenue, hospitals may want to revisit revenue cycle strategies, such as leveraging new technologies and analytics tools that help improve processes and coding to reduce claims denials. In our analysis, the largest drivers of hospital revenue, irrespective of hospital type, were case mix index and payer mix. Increasing the case mix from the median (1.45) to the 75th percentile (1.65) is associated with a 10 percent increase in operating revenue. The impact of Medicare and Medicaid payer mix was similar—a 10 percent increase in the share of Medicare patients or Medicaid patients decreases operating revenue by two percent.
To stay afloat—even thrive—in the face of margin pressures, health systems should consider identifying strategies to enhance revenue, reduce costs, and generally improve efficiency. New approaches such as using predictive analytics and Artificial Intelligence (AI) to improve the supply chain or robots and cognitive automation to enhance finance and revenue cycle processes have the potential to bend the cost curve and boost revenue in coming years.
To read the full report on how innovative technologies can improve hospital financial performance, download The uncertain road ahead: Could technology offer hospitals relief from increasing margin pressures?
- Deloitte Center for Health Solutions, “Deloitte 2017 Survey of US Health System CEOs: Moving forward in an uncertain environment,” https://www2.deloitte.com/content/dam/Deloitte/us/Documents/life-sciences-health-care/us-lshc-ceo- medicaid-reimbursement.pdf.
- American Hospital Association Resource Center Blog, “FORECASTING: Hospital payer mix 2014 and 2024, U.S.,” May 2, 2016, https://aharesourcecenter.wordpress.com/2016/05/02/ forecasting-hospital-payer-mix-2014-and-2024-u-s/.
- Jennifer M. Ortman, Victoria A. Velkoff, and Howard Hogan, “An Aging Nation: The Older Population in the United States Population Estimates and Projection,” United States Census Bureau, May 2014.
- Tamara Hayford, Lyle Nelson, and Alexia Diorio, “Projecting Hospitals' Profit Margins Under Several Illustrative Scenarios,” Working Paper Series Congressional Budget Office, September 2016, https://www.cbo.gov/system/files/115th- congress-2017-2018/costestimate/52849-hr1628senate.pdf