Not-for-profit hospitals' and health systems' median operating margins bounced back more than 10% in 2018 over the prior year following two straight years of margin declines, with the biggest gains concentrated at the low end of the ratings spectrum, according to a new report from Fitch Ratings.
The median operating margin was 2.1% in 2018 across the 220 not-for-profit hospitals and health systems Fitch rates, compared with 1.9% in 2017. Within that, AA-rated providers saw their median operating margins decline from 5.1% to 4.5% during that time. At the other end of the spectrum, providers rated BBB- saw their margins improve from -1.2% to -0.7%.
It's a "very good sign" for the industry that the lower-rated credits performed better, as they tend to be more vulnerable to the whims of the market than higher-rated systems, said Kevin Holloran, author of the report and senior director with Fitch.
"We're not out of the woods yet," he said. "But it's important to note those smaller credits made the most meaningful gains. This shouldn't be a flash in the pan. It should be an industrywide shift."
Fitch still maintains a negative outlook for the not-for-profit hospital sector, as it has for about two years, but Holloran said the agency will likely revisit that in November or December. He thinks operating profitability bottomed out in 2017, and will continue to inch back up in the coming years.
"The main story this year was we did not see an across-the-board degradation of margins," Holloran said. "We saw the industry pick itself up by the bootstraps."
Hospitals and health systems at the lower end of the rating spectrum tend to be nimbler and can implement changes more quickly than larger systems, which tend to be perpetually digesting mergers or other bold changes that draw time and expertise away from fundamental operations, Holloran said. And since lower-rated systems tend to be smaller, even minor gains or losses have a meaningful impact on their overall operating results.
As far as why operational strength is returning to the sector, Holloran said it's just because they're doing the "basic blocking and tackling." They're getting better at controlling salary and wage costs by staffing people at the top of their licenses and using less traveling personnel, he said. They're not overstaffing if volume does not require it. They're not paying overtime because staffing is at appropriate levels.
"That's literally half your expense base," Holloran said.
The other half is supplies, which invites questions over utilization practice patterns. How many suture kits are opened during surgeries? Can implants, sponges and gloves be purchased in bulk through a known vendor?
Addressing salary, wage and supply costs covers two-thirds to three-quarters of hospitals' expense base, Holloran said.
Another crucial area is revenue cycle. Are hospitals billing appropriately? Are bills being denied or sent back?
These aren't so much "initiatives du jour" as they are a way of life, Holloran said. "I would submit that we in the not-for-profit world have gotten a good dose of for-profit acumen shot into our DNA."
Outside of hospitals' own operations, market conditions are also having somewhat of an effect on margins, although that's a more mixed bag. Low unemployment rates, lots of people getting employer-sponsored insurance and a positive economic environment are all good things. For hospitals, though, a strong job market can make it tough to retain nurses, technicians, coders and others. There's also the ever-present threat of nontraditional entrants becoming increasingly interested in healthcare.
Margins for hospitals' median operating earnings before interest, taxes, depreciation and amortization also improved from 2017 and 2018, from 8.5% to 8.6% overall, with the biggest improvements seen in the lowest-rated systems. Systems rated under below investment-grade categories saw their operating EBITDA margins grow from 4.1% in 2017 to 5.8% in 2018. At the other end of the spectrum, all AA category credits did not see a change in their operating EBITDA margins during that time, which remained at 9.9%.
Data from Modern Healthcare Metrics, which aggregates information from the Medicare cost reports that hospitals submit to the CMS annually, identified a decline in median operating margins across not-for-profit hospitals in the years Fitch studied. In 2018, Metrics data show the median operating margin was 3.1% across 1,119 not-for-profit hospitals. In 2017, it was 3.3% across 1,943 not-for-profit hospitals.
Fitch's new report, 2019 Median Ratios for Nonprofit Hospitals and Healthcare Systems, did not include data on children's hospitals or hospital districts.
The report notes that hospitals' liquidity metrics were stable between 2017 and 2018, although they're at all-time highs for the industry. Overall median cash to debt dropped to 155% in 2018 from 159% in the prior year. Despite improved profitability, the BBB and below investment grade-rated systems saw declines in cash to debt, from 98% in 2017 to 91% in 2018.
