In conversations with hospitals and health system leadership across the U.S., most management teams express the same goal: get back to breakeven. For many, the road to breakeven will be bumpy with gains and setbacks along the way and certainly, as the Beatles put it, long and winding.
After better performance in 2021, largely supported by the CARES Act, the bottom line turned negative in early 2022. Kaufman Hall’s National Hospital Flash Report revealed monthly deficit margins were particularly pronounced in January and February (nearly 4%) as Omicron went viral and contract labor costs escalated. As the industry made its way through the balance of 2022, however, the median operating loss began to decline. The surges weakened, negative volume indicator trends turned positive, and for some, escalating expense growth rates began to curb. Toward the end of the 2022, the monthly deficit margin came closer to breakeven (-0.6%), climbing its way out of an ominous start to the year.
Early performance through February 2023 shows a continuation of the deficit margin, but some underlying positive trends suggest that the industry may be at a turning point. While still at an operating loss (-1.1%), the month-over-month variance in margin is declining, indicating that a new normal, albeit lower, level of performance may be emerging. Still, if a hospital’s financial performance cannot produce a positive operating margin, it is not sustainable, as the hospital will be unable to fund capital needs and invest in long-term strategies to support its mission.
The timing mismatch between multi-year managed care contracts and real-time inflationary pressures points to a fundamentally broken reimbursement model that the industry continues to grapple with. Price inelasticity is also a factor given a high government revenue mix for most not-for-profit hospitals. And most hospitals are price-takers, not price-setters, when it comes to managed care negotiations. These fundamental challenges won’t be solved in the near term, so an organization’s ability to quickly find its bottom line will largely be a function of doubling down on operations.
At our recent Rating Agency webinar, we discussed current financial performance and the road to breakeven with Suzie Desai (S&P Global), Kevin Holloran (Fitch Ratings), and Eva Bogaty (Moody’s Investors Service). All acknowledged that hospitals are working hard to return to breakeven with turnaround plans underway, but the journey to breakeven will likely not be concluded as soon as initially expected, given widespread labor challenges and slower-than-anticipated pickup in volumes. The agencies indicated that showing a breakeven run-rate, either on a monthly or quarterly basis, will be an important factor for rating committees. Likewise, absolute and relative liquidity metrics remain a focal point for ratings. But the industry’s longstanding ability to rely on cash no longer holds true given the downturn in investments, so much so that many are reinstituting cash preservation strategies, such as reducing capex, that we saw in the early days of the pandemic. This is only a short-term band-aid, however. At some point hospitals will need to step up investments in their plants to remain competitive on a local and regional basis.
The road back to breakeven will likely not look like a clean, linear line but rather more like a sawtooth. Sharing progress with the rating agencies on indicators such as volume trends or reduction in contract labor will show that the undergirding of the plan is taking hold. If your organization is not performing to the outlined plan, an unabridged discussion of what happened, and the steps being taken to course correct needs upfront airtime. Likewise, staying in touch with rating analysts between annual reviews is recommended if performance is not going according to plan. There are no truer words than “call early and call often” when it comes to building confidence with the rating agencies on your pathway to breakeven.