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April 30, 2018

Moody's finds that hospital margins hit a 10-year low. Here's our take.

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    Read Advisory Board's take on this story

    The median operating cash flow margin for nonprofit and public hospitals declined to 8.1% last year, falling below levels recorded during the 2008-2009 recession, according to a preliminary analysis released Monday by Moody's Investors Service.

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    The preliminary analysis is based on financial statements for fiscal year (FY) 2017 from 160 nonprofit and public hospitals and health systems with credit ratings from Moody's.

    Key findings

    The analysis found that nonprofit and public hospitals' median operating cash flow margin fell from 9.5% in fiscal year (FY) 2016 to 8.1% in 2 FY 017—its lowest level in a decade. According to the report, the decline comes amid growing expenses and pinched revenue growth, with expense growth in FY 2017 outpacing revenue growth for the second year in a row.

    Specifically, the researchers found nonprofit and public hospitals' median annual expense growth in FY 2017 exceeded annual revenue growth by 1.2%, up from the 0.7% increase in expense growth recorded in FY 2016. Overall, from FY 2016 to FY 2017, the annual median revenue growth rate decreased by 2.2%, while the median annual expense growth rate decreased by 1.7%, according to the report.

    The researchers did find that the nonprofit and public hospitals' median absolute unrestricted cash and investments in FY 2017 increased by 8.2%, in part because of strong market returns, up from an increase of 3.8% in FY 2016. However, the researchers said that growth was offset by slow growth in median days cash on hand, which increased by just 1.5% under pressure from labor, technology, and supply costs. According to the researchers, growing capital spending and expenses will hinder liquidity improvements.

    Factors behind declining revenue growth, according to Moody's

    The researchers attributed the decrease in revenue growth for nonprofit and public hospitals to several factors, including:  

    • An increase in the number of patients covered by governmental payors, rather than higher-paying commercial payors; and
    • Median growth in outpatient visits (2.2%) outpacing median growth in inpatient hospitalizations (1.2%).

    The researchers said they expect a number of factors will further heighten pressures on revenue growth, including an aging population, increasing levels of bad debt, and a lower rate of reimbursement.

    Meanwhile, the researchers said revenue growth resulting from health insurance coverage gains under the "Affordable Care Act (ACA) have been essentially realized." According to the researchers, the number of unpaid hospital bills and uninsured patients will likely grow as a result of the recently enacted tax reform law that beginning in 2019, effectively eliminates the ACA's individual mandate. 

    The researchers also cited an uptick in nonprofit and public hospitals' operating expenses, stemming at least partly because of a tight labor market. For instance, Lisa Goldstein, an analysist for Moody's and author of the preliminary report, said the nursing shortage is leading some hospitals to offer bonuses to recruit and retain nurses (Evans, Wall Street Journal, 4/23; Gooch, Becker's Hospital CFO Report, 4/23; Moody's Investor Service report, accessed 4/23).

    Advisory Board's take

    Eric Fontana

    Eric Fontana, Managing Director, Data and Analytics Group, Financial Leadership Council, and Emily Connelly, Consultant

    Moody's latest findings aren't surprising, but they're very concerning. For the second consecutive year, hospital cost growth outpaced revenue growth, and the gap between those figures is only growing. Moody's researchers expect expense growth to continue outpacing revenue growth into 2019, so hospitals and health systems must expect that these financial pressures are the new normal.

    But there's one aspect of Moody's analysis that we think is misguided. The report states that "new strategies to stimulate revenue growth will be integral as hospitals and health systems exhaust cost reduction strategies."

    Moody's is right that revenue growth, including from a greater focus on revenue capture, will be critical—but our research indicates that hospitals also have opportunities for substantial cost reduction. To maintain positive margins, hospitals will have to double down on sustainable cost containment strategies.

    To learn how to navigate this era of financial pressure, check out the Cost Control Playbook, a one stop destination for system-wide cost control strategies. It includes a customized tool to identify your organization’s top cost reduction opportunities as well as our recent report, The New Cost Mandate, which explores the drivers of the long-term margin challenge.

    Finally, to learn eight strategies to lower your costs permanently, join us for a webconference on Tuesday, May 29, on "How to move from cost-cutting campaigns to permanent savings solutions."

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