As we emerge from the COVID-19 pandemic, we face a changed reality. Expenses—particularly labor expenses—have reset at a higher level. Inflation is rising at rates not seen since the early 1980s. As the Federal Reserve tightens monetary policy in response to inflationary pressures, borrowing costs, which have been at historically low levels, will rise. The Fed’s efforts to deflate a balance sheet that has grown to nearly $9 trillion may make capital markets more volatile.
Given these headwinds, the integral role of revenue resiliency in maintaining hospital margin and cash flow generation will only intensify. When the pandemic’s operational disruptions weighed down income statements, balance sheet strength served as a counterbalance. Now that the balance sheet faces volatility of its own, healthcare leaders must renew their focus on operations and revenue generation.
Volumes have recovered, but remain below pre-pandemic levels
While volumes showed a rebound in 2021 from 2020’s steep declines, they remain below pre-pandemic levels. Patient days was the one volume metric that showed positive growth, likely driven by longer stays for hospitalized COVID-19 patients and a higher case-mix acuity from patients who had delayed care early in the pandemic.
Higher acuity care was a likely factor behind the fact that, even though most volume indicators remained below pre-pandemic levels, gross operating revenue (without CARES funding) grew 10% in 2021 compared with pre-pandemic numbers from 2019. Add-on payments for COVID cases also contributed to this growth. Acuity may have begun trending downward in the second half of 2021, however, and the growth in gross operating revenue was matched by a 10% growth in total expenses in 2021 as compared with 2019.
Changing demographics will limit price elasticity
As the U.S. population ages, Medicare and Medicare Advantage will constitute a greater portion of hospital revenues, limiting price elasticity with rates that are largely non-negotiable. Growth in Medicaid and the move to Medicaid managed care by nearly all states also will foster greater price inelasticity. That the change is already underway: On a combined basis, Medicare, Medicaid, and their related managed care structures rose from 59% of hospitals’ gross patient revenues in 2018 to 66% in 2021, according to Kaufman Hall data.
We anticipate that many states will revisit Medicaid budgets in coming legislative sessions. At the same time, increased federal spending and a very high national debt raise the possibility of further material Medicare reductions, similar to the Balanced Budget Act of 1998.
As the population continues to age, health systems’ ability to rely on commercial rates for revenue growth will wane. On average, commercial revenues represented only about one-fifth of gross patient revenues in 2021. As enrollees seek more care in 2022 and payer profit margins ebb, we would expect the next round of negotations between providers and payers to be tougher than during the past year.
Building revenue resiliency
Given these headwinds, a revenue strategy based on volume growth will be risky, especially if it is too reliant on recovering inpatient volumes.
Revenue diversification will be key to revenue resiliency, especially growth in outpatient services such as ambulatory surgery, urgent care centers, imaging centers, and other sites of care. Several factors should give urgency to this effort. Patients increasingly are either seeking outpatient services outside of the hospital’s ecosystem or delaying outpatient care. The pandemic greatly increased telehealth use and intensified a trend toward “do it yourself” healthcare. Non-traditional competitors have been active in these and other spaces; hospitals and health systems will need a speed-to-market approach as non-traditional competitors quickly build their presence in outpatient services, particularly in high growth markets with large, commercially insured populations.
Payment diversification also will be key. The pandemic exposed vulnerabilities of the fee-for-service system and we have seen new interest in diversification of the payment portfolio. We anticipate accelerated movement toward value-based payment models that will lessen dependence on volumes as the primary revenue driver.
The two traditional drivers of revenue—volumes and price—are both under pressure. To build revenue resiliency, health system leaders must seek new areas of growth and new payment models in the months and years ahead.
See an expanded version of this article in the April edition of BoardRoom Press, published by The Governance Institute.
For monthly updates on hospital financial performance, consult Kaufman Hall’s National Hospital Flash Reports.