Not-for-profit and public hospitals' revenue growth has edged ahead of expense inflation for the first time since 2015, according to a new report.
Median annual revenue growth rose to 5.1% while expense growth dropped to 5% in 2018, new preliminary data on 150 hospitals from Moody's Investors Service show. Although hospitals were able to meaningfully reduce their expense growth rate from 7.1% in 2016 to 5.7% in 2017, that didn't keep up with revenue growth's decline from 6.1% to 4.6%.
Mergers and acquisitions, steady patient volumes and revenue cycle improvements fueled rising revenue while cost-cutting initiatives, productivity boosts, the shift to lower-cost settings and a slowdown in drug price hikes curbed expenses.
"You are finally seeing some of hospitals' strategies come to fruition, but there are only glimmers of stability," Moody's analyst Rita Sverdlik said. "The pace of decline of profitability margins is slower than it has been in past years, but they are still down."
Median operating margins reached 1.7% in 2018, down from 1.8% in 2017. A more sustainable operating margin would be around 2.5%, said Christopher Kerns, executive director at the Advisory Board.
"That's still an anemic margin overall," said Kerns, which he added was held back by low revenue growth.
Hospitals have doubled down on their efforts to control spending, recognizing it is a permanent rather than temporary necessity, but there are still a number of competitive threats to their businesses, he said. They could also be more disciplined in hiring and reduce their supply costs, Kerns said.
"It does not mean that they are out of the woods yet," he said.
Median operating income and operating cash flow improved to $13.7 million and $74.4 million, respectively, compared to $11.9 million and $63.9 million in 2017, Moody's found. Although, operating margins were constrained by relatively flat volumes, ongoing staffing shortages, wage increases associated with lower unemployment and persistent high costs of specialty drugs.
Median growth in inpatient admissions was flat at 1.2% while outpatient growth slightly ticked up to 2.4%. Non-hospital owned outpatient departments offer lower costs in large part due to a lack of facility fees, which the CMS aims to eliminate in its site-neutral payment proposal.
The aging population also dampens hospitals' revenue, as Medicare now represents 47.2% of gross revenue, up from 45.8% in 2017. Commercial gross revenue declined for the third consecutive year to 31.1%, according to Moody's.
One of the biggest threats to hospital revenue growth is the outside disruptors poised to divert referrals and patients from high-cost settings, Kerns said. While emergency room visits increased, the growth rate tipped to the negative for the first time in five years at -0.2% as urgent care centers continued to open across the country, Moody's researchers said.
Hospitals will either have to offer a lower price or demonstrate a measurable quality difference to rationalize the higher costs, Kerns said.
"They have to embrace fee-for-value because that is where the competition is moving," said Kerns, citing providers like Medicare provider Chicago-based Oak Street Health. "There are various types of medical groups that specialize in populations of patients that have been thought of as 'negative margin,' but the disruptive players don't view them that way."
The continued admissions softening may not be related to increased competition, but rather suppressed demand, said Jeff Goldsmith, national adviser for Navigant.
"The growth in high-deductible health plans and patient exposure to cost of care has stifled demand for a lot of services," he said. "I don't think hospitals are losing market share, the market isn't growing as fast as it once was."
The average deductible has tripled over the last decade, and over half of employees who get coverage from their employer can't afford their top-end deductible, said Gurpreet Singh, a partner at PwC and its health services sector leader.
"That means they will make value choices," he said. Some hospitals will be able to differentiate themselves by building out lower-cost networks, some won't, he said.
A 0.75% cut to annual hospital payments used to pay for Affordable Care Act implementation will expire this year, which could boost top-line revenue, Kerns said. Although, Medicaid disproportionate share hospital cuts are looming, which may offset some of those gains. They are slated to start in October, although they have been postponed four times already, said Lisa Goldstein, associate managing director at Moody's.
"Who knows if they will delay it again or continue to kick the can down the road," she said.
Slower growth in total debt and improved operating cash flow resulted in a small improvement in debt to cash flow and cash to debt, according to Moody's. Though the median growth rate in operating cash flow margin remained negative at -2%, it marks a material slowdown following negative growth of 10.5% in 2017 and 8.8% in 2016, suggesting stability of margins.
Hospitals have relied on mergers and acquisitions to boost their balance sheets, although opportunities are narrowing. While there is still some room for consolidation, they may have to shift their strategy, Singh said.
About 93% of most metro hospital markets are highly concentrated, which means fewer choices for potential M&A partners, he said.
"I would expect many providers to be reevaluating their strategic identity," Singh said.
Given the heightened scrutiny on mergers, especially those in the same markets, providers will have to show real cost benefits of consolidation not only to the health system but to the community, Kerns said. These deals can't be simply viewed as a means to protect their pricing, he said.
"There are diminishing returns on using market leverage to get better pricing," Kerns said.
Many health systems are exploring alternative revenue sources related to venture capital, commercial real estate projects and other investment avenues. This could hold some potential long-term gains, but they should be pursued with caution, Kerns said.
"I would note a strong word of caution because this is not health systems' core competency," he said.