Board Members, Are You Paying Attention?

How does one read the tea leaves to know when a hospital is in trouble? I have six factors for you, courtesy of Moody's Investors Service.

Nonprofit hospitals rarely default on their bond obligations (only 17 Moody's-rated credits have defaulted since 1970), but when they do, the revelation tends to catch people by surprise. Remember AHERF, anyone? In any case, since that implosion last century, hospitals have had to pay a risk premium above what they would have otherwise had to pay for the privilege of borrowing money, say many of the analysts I talk to.

So while the Moody's report was intended to benefit institutional investors, many hospital boards have to be educated about this stuff, too. Kudos to Lisa Goldstein--a friend of HealthLeaders, a heck of an analyst, and author of the report--for putting it out there. Some of it is common sense, but when these kinds of blowups happen, a lot of common sense has long since left the building. So here are the factors that signal trouble:

1. Excessive emphasis by the board of directors or hospital management on "mission over margin," often manifested in recurring operating losses and high reliance on investment income
2. Board failure to check management's unfettered capital spending
3. Weak market share or a failure to establish a clear niche in a competitive market.
4. Inability to recruit physicians and attract volumes to replacement hospitals or new hospitals
5. Failure to plan for, and react to, weak local area economic conditions
6. Inflexible responses to cuts in Medicare and Medicaid

Most of this stuff is just ordinary blocking and tackling, but when major financial blowups happen, hindsight often shows that multiple blocks were missed and multiple tackles were broken. The report comes out as many observers see clouds on the financial horizon in general and for healthcare in particular. Of the 17 rated defaults that have happened in the past 37 years, 10 occurred before 2000 and seven have happened since then, indicating a modest increase in defaults recently. Growing challenges to the industry, according to the report, include rising capital investment and potential Medicare reimbursement cuts.

Often, rating agencies provide good early warning of investments going bad. But those warnings trickle out in the form of downgrades and outlook revisions. That's why rating agencies are there, after all--but ask those who got burned on collateralized debt obligations in the financial markets last summer whether the rating agencies provided enough warning?

To really get the full story about how bad or good the situation is, a little more digging is required. If you're paying attention as a board member or officer, you're likely to take steps to ameliorate any of the factors mentioned before they morph into a verifiable crisis. But the fact remains that in the coming years, some hospitals will default, lots of money will be lost, and someone who's supposed to be watching will have been asleep at the switch.