Marginal Maneuvers: Experts See Ongoing Financial Fragility
The very first sentence of the press release from the Chicago-based consulting firm Kaufman Hall, announcing the publication on March 28 the publication of the firm’s latest “National Hospital Flash Report: March 2023,” basically said it all: “Hospital finances are beginning to stabilize as razor thin margins become the new normal.” The report offered a wealth of data, but that simple sentence opening the press release summarized what hospitals and health systems are facing right now, as the U.S. healthcare system continues to reel from the various impacts of the COVID-19 pandemic. And the bottom line finance-wise is that the national average of revenue margins among hospitals in February was a dangerous -1.1-percent margin healthcare system-wide.
There is the ongoing labor shortage, especially of nurses, but also of technicians, of health IT professionals, and of revenue cycle management professionals, among others, that is keeping labor costs exceptionally high. There are the persistently high supply chain costs, which have softened very slightly, but remain exceptional. And there are the high costs of financing, as bond value downgrades increased in the first quarter of 2023, in response to ongoing financial fragility on the part of provider organizations. In other words, hospitals and health systems just can’t get a break.
“This continues to be a very daunting and challenging time that I don’t believe offers immediate recovery,” says Craig McKasson, chief administrative and financial officer at the Charlotte-based Premier Inc. What’s more, he says, “2023 will continue to be a very challenging time for healthcare as well. Supply chain costs, while improving, are still challenging. And the other thing that’s really impacting a lot of our health systems, which are regional in nature—volumes and demand aren’t coming back as hoped, either. So they’ve got revenue and cost challenges, and then there’s the set of challenges in terms of bonds. A lot of CFOs and CEOs are saying that this is the worst environment we’ve experienced in multiple decades.”
Erik Swanson, senior vice president of data and analytics at Kaufman Hall, who authored the Hospital Flash Report, agrees. “Pre-pandemic-level operating margins, even in normal years, were 3, 3.5 percent, he notes. “So this is not a high-margin business; it operates very much like utilities in many ways. And the argument can be made as to whether 3 percent is a sufficient margin to fund expansion, etc.” And even though “The core fundamentals have gradually improved since then, partly because of the large stimulus funding through the CARES Act, 2022”; but the Omicron variant ended up resulting in “an incredible rise in expenses,” with 2022 being the worst year since the start of the pandemic, financially speaking, he says.
Given all the pressures that hospitals and health systems are facing now going into at least the near future, “In talking with health system executives,” says John Klare, managing partner at the Naperville, Ill.-based Impact Advisors consulting firm, “those executives are telling me, ‘Hey, look, the numbers just don’t work.’ And if you go from a positive 1-percent margin to a negative 1-percent margin, the reality is that that statistical change is really understating the problems facing health systems. Traditionally, you’d see a 1- or 2-percent growth per year in revenues among hospital-based organizations, based on the expansion of services, etc.—a relatively modest growth in revenue. At the same time, roughly 55 percent of hospital-based costs has been labor. And, as all the experts are noting, labor costs are going to continue to remain high for the foreseeable future, even as supply chain costs are expected to moderate at least slightly over the next few years.
“Obviously, this is an ecosystem coming out of some very difficult times,” says Katie Sklarsky, a principal in the Chicago-based consulting firm Chartis. “In the past year, some stabilization, some creeping back towards positive operating margins,” says the New York-based Sklarsky. “But what you’re also seeing is that no one is reaching pre-pandemic financial performance. Some will eventually get there, but it will be a couple of years from now, and require pretty significant change. The way people are seeking care is different now. Historically, so many systems relied on their inpatient volume, but some of that is never going to come back. In addition, there’s inflation, and though the contract labor spend has stabilized, wages are going up, even as retention has improved. So the costs are going to stay where you they are.”
Longer-term implications: further consolidation, acquisition
Indeed, Sklarsky says, “Recovery could take several years. And the fact is that no one is doing well financially right now, though some systems are doing better than others.” And she goes on to look at what’s at stake as hospital and health system leaders face straitened financial circumstances for the foreseeable future, and that has to do with how and when they can invest for the future, as care shifts more and more not only to the outpatient sector, but into patients’ homes.
In that regard, Sklarsky says, “Any system that has already been innovating around digital care, including telemedicine or hospital-at-home, will probably have more to invest now. So anyone who can think about rethinking how they deliver care, will do better and recover more quickly, because they’ll be able to tap into other revenue streams. But hospitals that weren’t part of integrated networks, were already teetering before the pandemic. And what I’ve seen among some of the smaller standalone hospitals, have been struggling to survive. They’re going to have to take advantage of any state programs out there to support hospitals like safety-net hospitals.”
In that regard, Sklarsky says, what is inevitably on the horizon for smaller, standalone hospitals, especially those in financial trouble, is becoming acquired by multi-hospital systems. “They’ll either have to find additional support through being acquired, or find partnerships. Some in the middle will be able to be creative with payer arrangements. Especially in the government sector, ways to become more creative in addressing the social determinants of health, with government and other payers.”
Labor costs—and technology
All the experts interviewed for this article agree that hospital and health system leaders, in order to help their organizations survive to make it to long-term viability, have to do a number of things. “The ability for individuals to work remotely has certainly led to increased competition,” Kaufman Hall’s Swanson says, referencing the fact that hospital-based organizations sent as many workers home as they could during the first days of the pandemic, leading to the unanticipated outcome of a nationalized job recruitment market for professionals in areas such as health IT and revenue cycle management—an element further burdening them financially. Per that outcome, he says, “Organizations are becoming more proactive rather than passive, in recruiting. And in this market, you can’t just post a job ad and hope it will be filled. Organizations have to be more active, so, seeking out candidates, posting jobs more broadly, and actively recruiting some of the talent. And a number of organizations have had cybersecurity events as well, which are extraordinarily costly. It’s just as critical to ensure recruiting. But it is simply harder to compete, and salaries have gone up,” he says. And, he notes that cybersecurity costs have gone up considerably as well, further adding to hospital-based organizations’ burden, even as they struggle to recruit and retain cybersecurity professionals.
Most of all, Premier’s McKasson underscores, going forward, “Hospitals and health systems have got to enable manual processes with technology. They’ve got to become more efficient, per labor costs. So there’s got to be technology enablement to create more efficiency, and they need to do that now.” And with regard to the single biggest cause of recent labor-cost increases, that created by the pandemic-intensified nursing shortage, he adds that, “If you think about the administrative tasks the nurses have to do, there are ways to technology-enable that, so nurses can spend more time at the patient bedside. But it’s not just nurses, there’s a shortage of technicians, of administrative people, with the increasing costs of wages in other areas of the economy. People are leaving hospitals for other employment opportunities.”
