Health systems' scale not linked to higher revenue

New data from Navigant Consulting challenge the common perception that scale will improve healthcare providers' operations, researchers said. The report, which covered 104 highly rated health systems comprising about half of nation's hospitals, showed that there was no correlation between higher revenues and better operating margins from 2015 to 2017.

"There is no relationship at all between profitability and the size of the system," Goldsmith said, adding that most of the health systems analyzed had AA and A credit ratings. "This flies in the face of the conventional wisdom that has driven mergers."

Some that did the worst were roll-ups, where small struggling systems were acquired by bigger ones that wanted to dominate a market, Goldsmith added.

Two-thirds of the health systems analyzed experienced operating income declines over the three-year period. Health system operating margins dropped by 38.7% from 2015 to 2017. Not-for-profit system margins fell by 34% while for-profit system margins fell by 39%. More than a quarter lost money on operations in at least one of the three years, and 11% had negative margins throughout.

Hospitals' expenses grew by 3 percentage points faster than their revenues, leading to a combined $6.8 billion erosion of earnings, a 44% reduction. Top-line operating revenue growth fell from 7% (2015 to 2016) to only 5.5% from (2016 to 2017).

"Overhead should go down as percentage of operations when you merge, but that isn't necessarily the case," Goldsmith said.

Executives argue that scale is necessary in today's environment to drive more efficient, cost-effective operations. Bundling purchasing, attracting more physicians and patients, spreading risk, and better coordinating care across the continuum require more capital and control of a diverse array of services and assets, they say.

But policy experts counter that the primary interest is padding profit margins. It's difficult for insurers to survive without the dominant provider. They use that leverage through offer all-or-nothing contracts that inflate healthcare prices, economists contend.

"I think there is a gap between these proposed nine-figure 'synergies' and the realistic outcomes," Goldsmith said.

A number of health systems have had buyer's remorse, particularly when acquired hospitals don't align with the systems' overall strategy, said Thomas Fahey, partner at the law firm Nixon Peabody. They can also run into technology and data-sharing issues that can lead to inconsistent referral patterns, take on managed-care contracts that don't yield the expected bargaining leverage, and fail to gain market share in competitive markets, he said.

Still, there is plenty of momentum for mergers and acquisitions, Fahey said.

"A lot of which is being driven by the weariness of the independent hospital," he said.

While operating margins waned, investment returns covered up a number of operating losses in 2017. That makes for a precarious dynamic subject to the whims of the broader economy, Goldsmith said.

"When markets turn downward there are going to be a lot of naked swimmers," he said. "2017 was a great year for investment returns that has covered up a lot of operating losses."

Weakening demand for inpatient and surgery services has led to tighter margins. Waning reimbursement for commercially insured patients in states that didn't expand Medicaid, reductions in Medicare payments due to the Affordable Care Act, and the failure of "value-based" contracts to deliver enough patients to offset steep upfront discounts for insurers also contributed to deteriorating balance sheets, according to the report.

For instance, hospital losses in treating Medicare patients rose from $20.1 billion in 2010 to $48.8 billion in 2016, according to American Hospital Association analyses.

Health systems weathered rising technology costs related to electronic medical record implementation. They also spent a lot of money acquiring physicians and establishing clinically integrated networks aimed at satisfying alternative payment models, according to the Navigant report. Labor shortages and bolstered benefit packages drove up labor costs while hospitals endured rising specialty drug prices.

Hospitals should renegotiate contracts with vendors, eliminate duplicative layers of management, consolidate or close sub-optimal facilities, and take time to better understand physician behavior, Goldsmith said.

Health systems need to better control their referral networks, particularly those that rapidly added doctors, according to the Navigant report. They need to better schedule and coordinate care by matching referrals with health systems' sub-acute and ambulatory services portfolios, which may result in weeding out any low-performing providers.

Despite all the hype around "value-based" care, health systems have been slow to bet on new payment models, especially any that entail downside risk. Providers would get the most bang for their buck by tailoring value-based payment models to Medicare and Medicaid beneficiaries, Goldsmith said.

"The industry is in a vulnerable position right now politically and economically and it is the challenge of management and boards to do something constructive about it," Goldsmith said. "If they picked all the low-hanging-fruit, maybe they need to get a ladder."