The American Hospital Association has released a report that we prepared for them on the state of hospital finances—and the results are sobering. We are projecting 2022 to be the worst financial year for U.S. hospitals since the start of the COVID-19 pandemic. Our optimistic projections are for a 37% drop in operating margins, relative to pre-pandemic levels. Brace yourselves—our pessimistic projections show margins falling off a cliff with a possible 133% decline. And a growing number of hospitals are feeling the pain: More than half of all hospitals are projected to experience negative margins this year, up from 36% in 2021.
At this stage of the pandemic—late-stage, post, endemic, however you want to characterize it—battle-weary hospital executives would love to see macro-level financial projections heading in the right direction, if not returning to pre-pandemic baselines. But hospital costs have been rising as inflationary pressures, workforce shortages, supply chain disruptions, and drug expenses combine to drive up both labor and nonlabor expenses. Even in the few categories where expense growth is slowing, such as contract labor, costs remain far above pre-pandemic levels. To make matters worse, there is no additional federal financial support for hospitals in the foreseeable future.
So, how can healthcare leaders put these financial projections in perspective? Comparing current performance with the last pre-pandemic year provides essential information, but little reason for optimism. Unfortunately, reaching back to another time when hospitals experienced shared financial pain (albeit in very different circumstances) doesn’t inspire hope either. The Great Recession of 2008, considered the longest period of economic decline since the 1930s, resulted in widespread investment losses, liquidity constraints, and technical defaults on debt covenants for hospitals. Hospitals had to restructure and resolve these problems, which by and large they did. But healthcare employment and national healthcare expenditures rose consistently during the Great Recession, despite substantial cuts in other sectors of the economy. Profitability problems were not part of the recession picture for hospitals.
The reality is that the current financial condition of the hospital industry is worse than it was in 2008 at the peak of the Great Recession. The simple truth is that the pandemic and accompanying inflation have upended the longstanding relationships between hospital revenues and expenses. As a result, the pandemic cost structure of the hospital industry is operationally unsustainable. So, for better or worse, and like it or not, the strategic imperative right now is cost reduction.
As I said last year, the low-hanging fruit is gone. Traditional approaches to cost reduction won’t cut it. It’s imperative to apply new and smarter approaches to this endeavor. Going forward, every fiscal year will likely require a measure of cost reduction. This macro strategy is especially difficult for not-for-profit hospitals because innovative, assertive, and necessary cost reduction pushes against longstanding cultural characteristics and risk tolerance for most such organizations.
Nevertheless, executives of leading healthcare systems realize that large-scale cost structure changes must be made. In recent conversations, several executives told me that they don’t expect to be in a pre-pandemic revenue position anytime soon. As a result, they are grappling with major cost structure issues. And they are gearing up to make some tough decisions.
I’m often asked how permanent the current state of hospital finances will be. At this point, I think we can say that we are not going back to where we were in 2019. Our industry faces challenges that are structural in nature, not just cyclical (as with the economy) or situational (as with the pandemic). Are healthcare organizations that don’t change their cost structure foreclosing on their own futures? We don’t know the answer to that question. But the question must be raised and that, in itself, speaks volumes.