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September 14, 2018

Non-profit hospital margins just reached an all-time low. How should hospitals respond?

Daily Briefing

    Read Advisory Board's take: What does this mean for your hospital?

    Nonprofit and public hospitals in fiscal year (FY) 2017 saw their revenues decline at a faster rate than spending for the second consecutive year, bringing their profit margins to an all-time low, according to a new report from Moody's Investors Service.

    The report is based on an analysis of FY 2017 audited financial statements of 303 freestanding hospitals, single-state health systems, and multistate health care systems.

    Report findings

    Moody's Analyst Rita Sverdlik said the report showed that nonprofit and public hospitals' "[r]evenue pressures continue[d] to overshadow expense saving initiatives" in FY 2017. Sverdlik explained, "While the median annual expense growth rate decelerated" from 7.1% in FY 2016 to 5.7% in FY 2017, the "annual revenue growth rate declined faster," from 6.1% in FY 2016 to 4.6% in FY 2017. "This is the second consecutive year expenses have topped revenues and this will remain the largest strain on [nonprofit and public] hospital profitability through 2019," the report stated.

    Analysts largely attributed the decline in spending to hospitals gaining better control of labor and supply costs, and they attributed the decline in revenue to an increase in ambulatory competition, a shift from inpatient toward outpatient care, and lower reimbursement rates.

    Analysts also found more nonprofit and public hospitals reported an increase in operating deficits and a decrease in lower absolute operating cash flow in FY 2017. In particular, analysts found the share of nonprofit and public hospitals with operating losses increased from 16.5% in FY 2016 to 28.4% in FY 2017, and the share of such hospitals with lower absolute operating cash flow increased from 24% in FY 2015 to 59% in FY 2017—which represents a five-year high.

    In addition, analysts found median operating margins decreased from 2.7% in FY 2016 to 1.6% in FY 2017, and cash flow margins decreased from 9.4% in FY 2016 to 8.1% in FY 2017. Analysts said both decreases represented all-time lows. According to the report, nonprofit and public hospitals will continue to see margins suppressed through FY 2018. Sverdlik said, "Reversing sluggish volume trends and growing profitable service lines will be critical to improving the sector's financial trajectory over the near-term as most hospitals continue to operate in a fee-for-service environment."

    According to the report, nonprofit and public hospitals did see some promising signs of market improvement in FY 2017. Specifically, analysts found "[s]trong market returns and level capital spending improved the median unrestricted cash and investments growth rate to 8.9%." In addition, they found "[g]rowth in absolute cash exceeded expense growth, leading to improved median cash on hand to 209.9 days and median unrestricted cash and investments-to-total debt to 160.2%" (Ellison, Becker's Hospital CFO Report, 8/29; Jones Sanborn, Healthcare Finance News, 8/29; Masterson, Healthcare Dive, 8/30).

    Advisory Board's take

    Yulan EganEmily Connelly

    Yulan Egan, Practice Manager and Emily Connelly, Consultant, Health Care Advisory Board

    It is deeply troublesome to see that margins worsened in a year when the industry successfully slowed operating expense growth by 1.4 percentage points. The problem is clear: slowing operating expense growth didn't offset rapidly decelerating revenue growth, which continues to be depressed by a variety factors such as direct pricing threats, site-of-care shifts, new payment models, and more.

    “Traditional cost-cutting tactics likely aren't sufficient anymore”

    This isn't going to be a short-term problem; these financial pressures are continuing to hit hospitals despite the overall health of the economy. The structural nature of today's revenue pressures mean that hospitals and health systems can no longer maintain robust margins through revenue growth alone—cost containment is more important than ever. And traditional cost-cutting tactics likely aren't sufficient anymore. To maintain financial sustainability, hospital and health system leaders must hardwire cost discipline into their organizations to permanently bend the cost curve.

    Over the course of talking with more than 150 hospital and health system leaders, as well as industry experts, we discovered that cost-disciplined organizations:

    • Have low cost growth relative to revenue growth over time;
    • Manage closely to their budgets;
    • Avoid large swings in expense growth, such as spikes in spending and dramatic cuts; and
    • Are able to inflect categories of excess spending without unintended consequences.

    So how can an organization achieve cost discipline? We've spent the last year speaking with hospitals and health systems that have been able to achieve cost discipline in different areas, and we've distilled our findings into eight lessons.

    Download our brand new report—Toward True Sustainability—to learn how you can implement these eight lessons. Each one contains an overview of the most common problems hospitals face in that area, case profiles of organizations that have had success facing these challenges, and a blueprint for how your organization can adopt the solution.

    Get the New Report

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