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Hospital Operating Margins Slide 39% After ACA Expansion

Analysis  |  By Jack O'Brien  
   September 12, 2018

The three-year stretch between 2015 to 2017 saw widespread income deterioration along with declining operating margins, according to a new study.

Both nonprofit and for-profit health systems suffered significant operating margin declines associated with the expansion of the ACA between 2015 and 2017, according to a Navigant study released Wednesday morning. 

Average operating margins declined 39% overall, including 34% for nonprofits and 39% for for-profits, while 47% of hospitals saw "significant deterioration of operating earnings" and 22 systems experienced three-year operating income declines of more than $100 million.

The study found multiyear reductions in topline operating revenue growth along with uncontained expenses were to blame, falling from 7% from 2015 to 2016 down to 5.5% from 2016 to 2017. 

Additionally, 65% of systems experienced operating income declines totaling $6.8 billion, a 44% reduction over that three-year span. These declines were primarily experienced by systems in the West and South, regions with some of the fastest growing populations in recent years.

Most states in these areas decided not to expand their Medicaid programs under the ACA and now find themselves providing care to a larger population without the increased government reimbursements to compensate for costs. 

Related: 'Unsustainable Path': Nonprofit Hospital Finances Face Troubling Trend

Navigant analyst Jeff Goldsmith told HealthLeaders that systems have responded to declining margins by focusing primarily on cost-cutting measures, such as freezing capital expenditures, spending on travel or board education. Goldsmith added that some of the most positive operating income performances in 2016 can be attributed to systems who struggled in 2015 and corrected course to deal with the financial challenges facing them.

The financial challenges facing systems have also arrived in waves, according to Goldsmith, with regional Catholic systems experiencing the brunt of operating declines in 2016 while investor-owned systems struggled throughout 2017. Despite the confluence of unfavorable financial circumstances, Goldsmith said there are four areas of opportunity for CFOs to effectively curb the issues they face.

1. Rationalizing contracts with vendors

  • Goldsmith listed services that are commonly contracted out of system as areas where hospital leaders can recoup costs.
  • These include administrative support services, housekeeping and food services, consulting, as well as physician staffing contracts for major units like the ICU. 

2. 'Attacking the layers of management'

  • Goldsmith described this as the distance betweent the patient and the CEO, pointing to the effectiveness of corporate systems delegating what specific functions are tiered between the national, regional, and local levels of the institution. 

3. Pruning the portfolio

  • Some multi-hospital systems like Tenet and CHS have already begun the process of reexaming their portfolio of facilities and services that they operate.
  • Though this leads to operating revenue being dashed because of selling facilities or closing hospitals, Goldsmith said systems have begun to look at what is core to their operations.
  • The same goes for service line rationalization, according to Goldsmith, where hospitals are deciding to pull out of areas where there are multiple hospitals competing for the same population or offering duplicate programs.

4. Physician spend

  • Goldsmith clarified the aim is not to deal with the cost of large physician groups but rather the service contracts that require 24-hour call at the hospital, clinical directorships, and other forms of physician subsidy. 
  • Often, Goldsmith said, there have been instances of hospitals paying for physician-related services at well above their operating revenue growth rate, which puts additional financial pressure on the system. 

"I think, to be optimistic about it, that there are a lot of levers to pull here, that's the good news," Goldsmith said. "The bad news is a lot of those levers are attached nerve endings, and ultimately, it's going to take a change in the operating culture of these places to really put them on a sustainable footing."

Jack O'Brien is the Content Team Lead and Finance Editor at HealthLeaders, an HCPro brand.

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