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Is a Tidal Wave About to Wipe Out the Healthcare Sector?

Michael Sandnes, for HealthLeaders Media, May 21, 2008

Many hospitals and healthcare facilities have come face-to-face with the reality that factors largely out of their control, like insurance reimbursement and government funding, will ultimately determine whether they survive—perhaps in a different form with a new owner or in a downsized facility—or shut down.

This environment creates huge challenges for chief executive officers to stay one step ahead of the executioner, as the current situation only offers the dark promise of higher operating costs and dwindling margins.

To CEOs, it can seem like a never relenting recurrence of Nightmare on Elm Street, as many healthcare leaders are kept up at night by the impending threat of:

  • Increasing competition from freestanding, investor and physician-owned diagnostic and treatment facilities.
  • The growing cost and complexity of technology and IT infrastructure.
  • The need to constantly improve quality and patient safety.
  • Continuing shortages in the labor supply.
  • The existence of nearly 47 million uninsured Americans.
  • State-level challenges to the not-for-profit status of well-run nonprofit healthcare systems.
  • Federal and state pressures on Medicare and Medicaid reimbursements.

These and other environmental trends are impacting the hospital industry as never before. While healthcare nationally continues to grow in dollar value and as a percentage of GDP (from 8.8% in 1980 to 16.1% in 2007), the hospital share of the national healthcare budget has dropped precipitously. In 1980, for every $100 spent on healthcare, over $41 was spent on hospital services. In 2007, that number dropped to $29. This ongoing trend will only result in continuing revenue pressure on hospitals at a time when demands for capital have never been greater--resulting in a "capital shortfall" where use far exceeds available resources.

Over the next few years, hospital industry experts expect a period of prolonged difficulty, characterized by increased revenue uncertainty and cost pressures, reduced access to capital, and a continued erosion of public and political support. Coupled with the ongoing operational challenges of aging physical plants and equipment, as well as the environmental challenges mentioned earlier, there is growing concern for the health of the industry and its long-term ability to meet the needs of the communities it serves—especially the poor and underserved.

A Movement towards 'Deeper Waters'
Within the last few months several major healthcare facilities located on the eastern seaboard, ranging from nonprofit acute-care hospitals to imaging centers to nursing homes, have filed for Chapter 11 bankruptcy protection. Simply put, they ran out of cash. Decreased reimbursement and rising costs, with an overabundance of indigent care, aging facilities, and expensive technology, are responsible for this deteriorating trend, with indications that more bankruptcies loom on the horizon.

Increased Chapter 11 filings will likely become a common occurrence in states like New York, New Jersey, California, Florida, Michigan, Texas and Hawaii, which have high healthcare delivery costs and declining economies. In addition, the advent of the "Federal Initiatives Deficit Reduction Act of 2005," created to establish a Medicaid Integrity program, will have a large impact on imaging centers because the federal government has lowered its reimbursement to them, which threatens their operating margins and future stability. It also appears that the government feels some states have an overabundance of healthcare facilities and only the strong will survive. Organizations will need to have a lean operating expense and a continued commitment to generating marketing referrals and getting their new business bill out and collecting on it.

As a result of all of the above considerations, I see the following sectors under attack:

  • Nonprofit acute-care healthcare entities with aging facilities, outdated equipment, and slow management process. Those with limited access to cash and high indigent patient populations--primarily those in urban centers—will continue to face difficulties.
  • Senior living centers including nursing homes and assisted-care facilities. The nursing home industry has had its up and downs, but without question reimbursement will continue to decrease, as will operating margins. The nursing home sector has many old facilities that lack the resources to update their buildings. And the assisted-living industry will continue to face an increase in market competition for private-pay patients.
  • Imaging centers. This group will continue to be hit hard. Reimbursement rates for imaging procedures have already declined 40% to 50% since January 2007 as a result of the Deficit Reduction Act and the government's conclusion that too many centers exist and consolidation is necessary in order to reduce unnecessary imaging procedures from being performed. There will also be a dramatic slowdown in the number of facilities purchasing new technology (CT/PET) over the next 24 months, resulting in a flooding of the market with aging overvalued equipment. Imaging centers operating expenses, supplies, and labor will likely increase. As a result, high patient volume will become crucial to handle debt payment and the increasing restrictions on referral practices, as the drop in reimbursement rates will force centers from doing three to four scans per day to performing 10 to 12 to cover expenses.

Other Likely Scenarios
It's not all gloom and doom. I also believe that:

  • Long-term acute-care centers, which in the recent past have experienced declining reimbursement rates and cutbacks, will make a slight turnaround and continue to be in demand. I believe CMS will change its view of them and arrive at the conclusion that it likes the patient-care model and short stay.
  • Continuing-care retirement centers will enjoy continued growth and begin to exploit opportunities in this portion of the senior living sector. The ideal model is a small nursing home, assisted-living center, apartments and outpatient center housed on one large campus.
  • Pharmacy companies will continue to fight for increased market share and aggressively pursue acquisitions.
  • Medical equipment manufacturers will have increased competition from China and select European countries.
  • Healthcare companies and networks will seek affiliation partners to gain market share.

It's going to be a turbulent time for the healthcare sector. Only the savviest healthcare leaders will weather the storm unscathed.


Michael Sandnes is the director-healthcare services practice for Executive Sounding Board Associates, in its Baltimore office. He leads turnaround and crisis management engagements with emphasis in the areas of profit restoration/improvement, organizational restructuring/planning and M&A integration in the healthcare arena. He can be reached at msandnes@esba.com.