Cost-cutting keeps profits high
Hospitals provided free services, made money in ’09
Hospitals gave out more free care than ever in 2009, but the latest statistics show the industry still posted record operating profits. Observers said the financial performance amid the recessionary aftermath was so strong it may actually become a political liability in Washington, where industry lobbyists and critics will continue to tussle over federal reimbursement formulas.
“If the industry shows healthy growth and margins, it will be difficult to convince the federal government to provide the increases we’ve been able to receive in the past,” said Sidney Sczygelski, senior vice president of finance and chief financial officer at four-hospital Aspirus, Wausau, Wis. “If we’re transparent as an industry about what is going on, hopefully the right story will be told and the right decisions made.”
According to the latest industrywide figures, released last week by the American Hospital Association, the 5,008 community hospitals in the 2011 AHA Hospital Statistics guide record- ed solid financial performance in fiscal 2009.
Hospitals reported $34 billion in total profit on $690.5 billion in net revenue, for a total margin of 5%. That compares with total profit of $17 billion on net revenue of $643.6 billion in 2008, for a total margin of 2.6%.
Net revenues grew at a faster-than-typical 7.3%, while expenses grew much more slowly, at 4.7%. Over the past 25 years, expenses and revenues have grown at exactly the same average rate: 6.9% annually.
Hospital financial experts say the key figures they focus on are not net revenue, but rather operating revenue, which include only patient care and long-held ancillary businesses like gift shops, parking lots and cafeterias.
In 2009, profits from operations broke the record since the AHA began keeping operating revenue statistics in 1992. Hospitals recorded $30 billion in profits last year on $686 billion in operating revenue, for an operating margin of 4.4%. That was up from the 3.3% operating margin the year before.
Larry Fitzgerald, associate vice president for business development and finance at the University of Virginia Heath System, Charlottesville, said hospital administrators across the country scrambled to find ways to cut expenses while keeping core operations stable.
“I think what we saw,” Fitzgerald said, “is an industry that was experiencing a major decline in inpatient volume and an opinion on the part of hospital experts that that volume was not going to recovery rapidly. So you saw hospital operators respond, and the only way they could was a reduction in hospital expenses.”
Mainly, those cuts came in two areas: supplies and labor. With supplies, experts said many hospitals cut back on the variability of their supply chains while standardizing purchasing across departments or even entire health systems.
But virtually every hospital’s largest expense is labor. In 2009, payroll and benefits constituted 52% of all hospital expenses, or $338 billion of the $656 billion in expenses, the AHA statistics say.
Many hospitals froze all hiring and did not give wage increases in 2009, insiders said. In many cases, those that did not conduct outright layoffs instituted attrition programs or reengineered jobs to make workflows more efficient.
However, experts differed on whether the 2009 cuts in expenses—and, therefore, operations gains—will remain intact in coming years.
Jim LeBuhn, a senior director in the U.S. public finance group at Fitch Ratings, said many of the cost-cutting measures were essentially “stop-gap measures” destined to be rolled back in coming years.
“Some of the actions that organizations took to maintain profitability are measures that really can’t be sustainable, particularly as it relates to wage freezes and some curtailment of benefits,” LeBuhn said, adding that the widespread halt in capital investments in facilities and equipment can’t be sustained in the long run.
Caroline Steinberg, vice president for trends analysis for the AHA, said that while gains in revenue in 2009 may have been faster than some experts would have predicted, the capital isn’t destined to remain in hospital coffers for long.
“Hospitals are gearing up to make more
investments in health information technology, and with all the difficulties in the capital markets, hospitals are forced to look at selffinancing instead of borrowing,” she said.
Fitzgerald, however, made the prediction that 2010 will set further industry records for operational profitability, as the patient volume inches back toward pre-2008 levels without adding to the basic hospital cost structure.
“We’ll look back on it and probably suggest that there were cost reductions that could be effectuated that had not been historically, so this forced a hard look at expenses across the industry,” he said. “We would have rather had it not occur, but patient quality has not suffered, and access to care has not suffered. We may look back and suggest it was good for the industry.”
With all of that operating revenue sloshing around the system after the worst recession in decades, healthcare observers say the industry ought to get ready to explain its figures to the public.
“From a PR standpoint, it’s going to be hard to argue that you need a big increase in your Medicare reimbursements if you’re doing as well or better than you have for the past 25 years,” said George Whetsell, managing director at Wellspring & Stockamp, Huron Healthcare. “They’re not making outrageous profits, but to the degree that the numbers say they’re doing as well as they have, it’s not the best PR situation to be in.”
In terms of patient revenue, many of the gains came from reductions in bad debt and other revenue-cycle improvements—and not from price increases, which are either negotiated with payers or dictated by federal and state governments, experts said.
In the revenue cycle, hospitals have put far more focus in the past few years on collecting co-payments and deductibles at the point of care, Whetsell said.
Even so, U.S. community hospitals—fourfifths of which are exempt from taxes—provided $39.1 billion in care for which they were not paid in 2009 ( See related story, p. 10).
But experts like Steven Rousso, senior principal with HFS Consultants in Oakland, Calif., say the key to understanding the hospital financial equation is not revenue, but volume.
Hospitals tend to draw relatively low profit from each patient, since their overhead costs are so high. A Modern Healthcare analysis of the latest AHA statistics shows, for example, that hospitals earned just $84.43 in operating profit for each “adjusted patient day,” which is a measure of the number of hospital inpatients plus an equivalent amount of work required for outpatient care.
Yet the hospitals shouldered $10,045.15 in expenses for each adjusted patient day.
So if it cost more than $10,000 to make $84 in operating profit, hospitals needed a huge volume to make ends meet. In 2009, hospitals treated 642 million outpatients, including ER visits, and provided 193 million days of inpatient care. (For reference, the U.S. Census Bureau pegged the national population at 307 million that year.) Observers said volume trends were profoundly affected by the recession, which caused millions of Americans to lose their health insurance and delay elective procedures.
For example, 2009 was the first year in a decade and a half to see a significant decrease in new inpatient admissions, which dropped by almost 1%. The drop in total inpatient days was even starker than admissions, down almost 2%.
Emergency room volumes rose by almost 4% in 2009, but that rise didn’t appear to translate into more hospital admissions. “That does tell you people might be having trouble accessing primary care,” the AHA’s Steinberg said.
Sczygelski said the finance and volume trends seem destined to exacerbate the division between haves and have-nots in the U.S. healthcare system.
“It’s becoming almost like two healthcare systems in this country,” Sczygelski said. “The larger organizations that have well-integrated care, that are geographically located for synergy, they’re going to continue to do well. I think the smaller hospitals, the standalone organizations are going to continue to struggle and lose money unless they are creative around making relationships with larger systems.”
One section of hospital financial statements that experts said attracted far less anxiety in 2009 than in years past was investment performance.
In recent years, investment portfolios have proven to be by far the most volatile aspects of hospital revenue, boosting hospital net profits to all-time highs under the meteoric rise in equity value, and then retracting a decade’s worth of profit growth when the markets tanked.
In fiscal 2007, investments added a whopping $17 billion to their revenue statements, boosting what was otherwise a ho-hum year for fiscal performance to a 6.9% net margin on $43 billion in total profits, which both were all-time highs.
Then in fiscal 2008, many fiscal officers were forced to make massive write-downs as the previous year’s investment profit turned into a $4 billion net loss that under accounting rules must be booked on revenue statements—in all, a stunning $21 billion reversal for the industry.
In contrast, investment managers saw a modest $4 billion investment profit in 2009— about the same level of investment income as was realized in 1994, the AHA figures show.
Fitch Ratings’ LeBuhn said the upheaval has caused bond analysts and healthcare executives to renew their focus on operations, and to pay less attention to their investment portfolios. “There has been a greater appreciation for managing those things that are in your control,” LeBuhn said.
Steinberg said the $8 billion negative-topositive swing investment performance in 2009 was surprising for its speed, but she agreed that the experience of the last few years has left many executives circumspect about their investments.
Fitzgerald said expenses were cut but stability remained.
Sczygelski: “Hopefully the right story will be told.”