Things are very much in flux right now for hospital-based organizations nationwide. On the one hand, overall financial performance has stabilized, certainly compared with a year or so ago. As we reported on Feb. 28, “Hospital-based organizations are gradually coming back from the depths of their fragility during the worst of the COVID-19 pandemic that devastated them financially during most of 2020 and 2021, though their recovery continues to be slow and partial. That’s what leaders at the Chicago-based Kaufman Hall consulting and advisory firm have found, in their ‘National Hospital Flash Report: February 2024,’ which they released on Feb. 28. As they noted on Wednesday on the firm’s website, ‘Hospitals’ financial performance in January improved relative to previous years, according to the latest National Hospital Flash Report from Kaufman Hall. While margins declined slightly from December, they were higher in January relative to the same periods in 2022 and 2021.” In fact, average operating margins went from 1.9 percent in December to 5.1 percent in January, a meaningful increase. But there is complexity underneath that marquee statistic.’”
At the same time, the very fluidity of the hospital financial landscape was underscored in January, when Kaufman Hall leaders published their most recent report on merger and acquisition activity, entitled “Hospital and Health System M&A in Review: Financial Pressures Emerge as Key Drivers in 2023.” Anu Singh, managing director, and practice leader for M&A at Kaufman Hall, wrote that, “In our 2022 year-end report, we noted that M&A activity had regained momentum following a two-year slowdown in the wake of the Covid pandemic. This momentum continued through 2023 with 65 announced transactions, up from last year’s total of 53. Sixteen of the 65 transactions were announced in Q4. One significant change, however, was the increase in the percentage of financially distressed organizations that sought a partner in 2023. Hospitals and health systems faced one of their most challenging years in 2022, with median operating margins staying in negative territory throughout almost the entire year. Those financial pressures emerged as a key driver of M&A activity in 2023, with financial distress cited as a factor or otherwise evident in 28% of announced transactions, compared with 15% in 2022.”
Indeed, Singh went on to note, “Financial distress is one factor driving the continued climb of the median size of smaller parties by annual revenue during 2022 and 2023 compared to historical trends; the median size has doubled since 2019 (Figure 3).[1] As noted later in this report, we are seeing an increasing number of larger systems citing financial distress, a change from the historical concentration of distress in smaller hospitals and health systems. At the same time, we are seeing the percentage of transactions in which the smaller party has a credit rating of “A-” or higher holding steady, as shown below in Figure 8. This underscores that fact that creditworthy organizations and community hospitals have also recognized the need for a strategic partner.”
Per all this, Healthcare Innovation Editor-in-Chief Mark Hagland sat down recently with Erik Swanson, Kaufman Hall’s senior vice president, data science and analytics, who is the author of the National Flash Report, for a check-in on the current financial landscape for hospital-based organizations. Below are excerpts from that interview.
Looking at the overall financial landscape for hospital-based organizations, as well as the M&A outlook, what are you seeing right now?
A few things. One is that it is clear across the board that we are continuing to see recovery and strengthening of performance. There is improvement on cost per volume; costs themselves continue to rise, but there as been attenuation relative to growing volume. Revenues have continued to grow, and we’re seeing a return to more-normal patient patterns, and also, the ability of some organizations being able to drive ambulatory sector growth. Still, we’ve been seeing these median operating margins in the 5-percent range; that’s pretty strong. But I think that some of what we’re seeing here is related to end-of-year adjustments, and I think that will decline, but we’ve already seeing better performance at this time of the year than in years past.
For January, the 5.1 percent median operating margin—that’s really good overall, correct?
Yes, that’s on the upper end of what we’ve seen historically. But Ken Kaufman and I recently wrote a piece called “The Numbers Behind the Numbers.” And while those margins have improved, what you don’t see here is that the gap between the higher and lower performers has increased substantially; the highest performers have gotten really, really good, while the rest have continued to stagnate.
About what percentage of hospital organizations are we talking about in terms of the higher-performing organizations?
It’s about one-third of hospitals. And the better the operating margin is, the greater the probability of faster growth. So the curve is actually exponential, which leads to a lot of interesting conclusions around what it means for the highest and lower performers.
That will inevitably lead to intensified consolidation, won’t it? The smaller and rural hospitals aren’t coping well now, and will need to join systems, correct?
Yes, that’s correct. Take your rural hospital and look at the cost of labor, and delivering services like women’s services; and many are closing those services. So we’re seeing women’s health deserts developing principally in rural health. And so what does it mean to provide healthcare services in some of those geographic areas? Regulatory environment aside, absolutely, more consolidation.
Many executives of hospital-based organizations will have to begin to think strategically about which service lines they offer and where, won’t they?
Absolutely. Many of our clients are looking at service line performance now already. And the other implication is that as lower-acuity patients are pulled outside the hospital, hospitals’ acuity is going to rise over the long term, and therefore, we’ll have higher-acuity patients in the hospital. So hospital leaders need to think about what types of services they offer today and where. It may mean more centers of excellence. So that will make this conversation all the more important.
They’re going to have to make real-time analyses and decisions about resources, including human resources, and will have to streamline, right?
Yes, and under that, how will value-based and risk-based arrangements play into this? You’re going to see continued vertical integration; we’ll see that continuing to grow. And organizations have to be equipped to make these decisions and be better able to predict; and the reality is that organizations will need these analytical capabilities to accurately scenario-plan. And it won’t purely be about lowering costs, but also about access, services, etc. There might be instances where a hospital organization will subsidize a service line for good reasons, and that will continue. But yes, they’re going to have to deliver the best care at the lowest cost and deploy their resources in the most effective manner.
Do you have any explicit advice you might be able to offer to senior hospital and health system executives, per all of this?
It’s more or less what we’ve been talking about, but it’s principally recognizing that the way in which care is being delivered is transforming, and hospital leaders need to understand what’s happening right now, and prepare for the future; that’s the reality of it.
Data analytics will be essential for success going forward, correct?
Yes, that’s correct. And what we’re seeing now over these last couple of months, is that if these margins continue to hold, it will call for investments in the future, not only physical, but also digital.
It seems that we are inevitably looking at a rich hospital/poor hospital gap continuing to emerge?
I wouldn’t necessarily frame it that way, but I would say that there are absolutely moves that will set organizations up for success. And there are stories of hospitals in traditionally underserved areas, that are doing well; and there are hospital organizations in more affluent areas, that aren’t doing well. But we’re seeing a real strategic gap.
