Not-for-Profit Hospitals Tighten Oversight as Revenues Fall

Not-for-profit hospitals are better managed and are learning to do more with less revenue. Now the question is whether or not the sector can continue to find savings in the coming years with much of the low-hanging fruit plucked and an aging demographic increasingly straining resource, Moody's Investors Service says.

Mark Pascaris, vice president and senior analyst at the bond rating agency, says that not-for-profit hospitals will continue to endure a negative credit outlook for the near future because of challenges to top-line revenues.

"The federal government pulling back on Medicare reimbursements, commercial payers becoming tighter in the types of rate increases they give to hospital and health systems year over year— that hasn't changed," Pascaris said in an interview.

"But we believe that as a sector, particularly among the rated hospitals, the management teams have become more focused on expense management and really have weathered the storm coming through the recession and the subsequent anemic economic recovery."

The Congressional Budget Office in February reported that total healthcare spending for the past three years increased at a historically low level of about 4%, which was slightly higher than 3% inflation in 2011 in the overall economy as measured by the Consumer Price Index.

That slowing of healthcare inflation, fueled in part by reduced federal funding, has mixed credit implications for not-for-profit hospitals, Moody's notes. Pascaris, however, says four years of significantly lower healthcare inflation cannot be attributed solely to the slow economy or reduced revenues.

"That first couple of years of that low pace of healthcare inflation, folks were attributing it to the Great Recession and higher unemployment and people with jobs either losing health insurance or being transferred to high-deductible plans. All of those things certainly were a factor," he says. "But now that we are at a multi-year trend of this kind of inflation in our view a component of this has to do with improved management in the sector driving down a lower sector-wide rate of inflation."

Medicare and Medicaid spending now represent 23% of the federal budget, the largest slice. The CBO has projected that by 2020 spending on Medicare and Medicaid will be cut by $200 billion less than what it had projected for the programs in March 2010. Because Medicare and Medicaid combined generate about 57% of gross revenues for most not-for-profit hospitals, the effects of any funding cuts are significant.

"On balance, however, we view the trend favorably for the industry as it drives management efforts across the sector over multiple years to control spending and portends a more efficient delivery model than in past years," Moody' says in Lower US Healthcare Inflation is Credit Positive for Not-for-Profit Hospitals.

"The trick," Pascaris says, "is going to be on the expense management side of things keeping that pace moving forward."

"The percentage of the population age 65 and older is expected to grow and grow over time and those are the folks who consume more healthcare resources," he said. "That coupled with a lot of the expense management efforts over the last three or four years have been low-hanging fruit like renegotiating supply contracts and right-sizing staff levels, things of that nature."

Many hospitals are focusing on the next level of expense reductions that include harder-to-find and longer-term efficiencies in areas such as enforcing standardized clinical protocols, improving patient throughput, hand-offs, and post-discharge care coordination.

"At some point you have to reengineer the process of healthcare management, which is really where a lot of the more sophisticated and aligned health systems are right now in trying to redevelop the throughput of healthcare—rethinking that altogether," Pascaris said.

"We think the next phase of expense management is probably going to be more difficult in terms of restructuring the process of healthcare delivery and that is probably going to be a bit more disruptive coming into an era where more of the population is at that Medicare eligibility," he said.

"It is going to be that much more of a challenge moving forward, which is part of the reason why we have seen and will continue to see more consolidation in the industry, more hospitals joining together or joining larger health systems to take advantage of economies of scale."