Health System Operating Margins Jumped 13% After Three-Year Slump, Challenges Still Ahead

Revenue growth and expense control led the way for provider organizations, according to a Navigant analysis.

Health system operating margins improved during 2018, increasing 13% year-over-year, but face future challenges according to a Navigant analysis released Wednesday morning.

Provider organizations benefited from sustained revenue growth and effective expense control tactics last year, breaking a three-year cycle of continued margin deterioration—a decline of more than 38% from 2015 to 2017. 

Almost two-thirds of health systems experienced margin improvements in 2018, a near-reversal from 2015 to 2017 when 66% of organizations saw margins deteriorate. The four-year study analyzed 103 large health systems that own 44% of hospitals nationwide. 

According to the report, "revenue growth exceeded expense growth in 2018 for the first time in three years, with revenues growing at more than double the rate of expenses from 2017 to 2018."

While 2018 marked an improvement, provider sector operating margins still lag behind the performance metrics from 2015 and face market challenges going forward.

Jeff Goldsmith, PhD, national advisor to Navigant, tells HealthLeaders that there is an increased likelihood of a recession, which would create a greater financial strain on health systems emerging from a three-year slump.

"My message has been that [executives] really need to have their act together, both operationally and financially, to prepare their institutions for tougher times," Goldsmith says.  

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M&A drives revenue, but doesn't fix everything

When the study examined the health systems' approaches to driving revenue and breaking the three-year margin slump, one of the most effective approaches was through mergers and acquisitions (M&A). According to the Navigant study, 15 systems reported revenue growth exceeding 15%.

Some of the most prominent deals cited in the study were ProMedica-HCR ManorCare, UPMC Pinnacle, and Advocate Aurora Health. 

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However, at the same time, Goldsmith says that the four-year study found a negative relationship between scale and earnings momentum. While many provider executives may think that they can solve expense challenges through M&A activity, Goldsmith refers to this approach as a "data-free set of assertions."

He says that clinical synergies are difficult to realize for merging health systems, specifically pointing to the lack of service rationalization along with issues related to integrating electronic health record (EHR) systems and achieving supply chain savings.

"There is no evidence that there are inherent economies of scale in this business," Goldsmith says. "If they exist, they are going to be produced by aggressive management action, and if that aggressive management action doesn't happen, then you don't get them."

Margin improvements realized, efforts need to continue

Goldsmith says that results from 2018 in the study show that revenue growth strategies and expense control measures have paid off for health systems, and executives "have gotten a handle" on the value-based contracts they signed a few years back. 

"[Executives] are beginning to learn how to much more aggressively manage the portfolio of contracts they have," Goldsmith says. "I think that the next couple of years are going to be a period of tough bargaining between health plans and health systems, stimulated by the learnings from this two-year catastrophic drop in earnings."

In the context of a looming fear of a recession, Goldsmith says health system executives should view the margin improvements in 2018 as a "down payment" on more aggressive approaches to revenue growth and expense control. 

He added that executives must focus on 'rebalancing' revenue portfolios and managing payer contracts and relationships on a monthly basis instead of budgeting for expense targets two years in advance.

Recommendations for sustained success

In addition to Goldsmith's suggestions, the study authors also offer five solutions to health systems for maintaining operational improvements. 

These include controlling labor and supply costs, achieving ROI on physician employment, service line rationalization, competing with nontraditional providers for ambulatory market share, and active management of revenue portfolios.  

Improved revenue cycle management (RCM) systems have served as a boon for health systems, according to Michele Mayes, study author and managing director at Navigant, who tells HealthLeaders, "In my mind, [RCM] is two things: it's being able to collect the money [a health system] is due and also being able to hang onto it." 

Additional notes:

• The most significant margin improvements were in New England and South Central regions, with the former being the only region where margins are higher than the 2015 performance metrics.

• Goldsmith says that he was "stunned" at the struggles by provider organizations in the Southeast region, which are primarily investor-owned hospitals. 

• He adds that provider organizations in faster-growing regions, like the Southeast, might have "overexpanded" their resources by spending money to "lay down the corners of their markets" by establishing retail clinics and employing physician practices.