December 29, 2022 06:00 AM

Operating margins

Positive operating margins may be out of reach for many hospitals and health systems in 2023.

Health systems are working to reduce high contract labor costs while still managing staffing shortages. They are also absorbing increased expenses when payers’ reimbursements fail to keep up. If poor margins persist, some systems, particularly smaller organizations, may be forced to make big operational changes.

As of October, the median hospital operating margin index was -0.5%, compared with more than 4% a year earlier, according to consulting firm Kaufman Hall’s monthly flash report. The index is based on the national median of data pulled from more than 900 hospitals. For-profit systems, in general, are faring better than nonprofits in the current environment.

Erik Swanson, senior vice president of data and analytics at Kaufman Hall, said he expects margins to be “significantly depressed” moving into the new year.

“We are still going through a period of shift, although not the level of fluctuations that we have had in the past,” Swanson said. “I suspect that 2023 may not be a point at which we reach the new normal. What I suspect is there will be a continuation of some of the trends that we’re seeing, but it will begin to be more clear what that new normal will look like.”

With operational issues here to stay, healthcare providers will continue to seek new methods of care delivery and to reassess what services should be offered–an effort to stabilize an industry that has largely been considered recession-proof in past downturns.

Staffing issues

Health systems scrambled to hire contract labor at premium prices in 2022 as staff burnout and COVID-19 exposure left gaps in patient care. The organizations are actively working to reduce their reliance on contract labor, but experts say the demand for it will take a while to normalize. The healthcare industry is short up to 2 million nurses, credit ratings agency Fitch Ratings estimated in its December outlook report.

Systems are competing on salaries and bonuses and, in addition, battling the pull of large corporations such as Amazon or Target for some full-time positions, Swanson noted.

Dallas-based Tenet Healthcare Corp. began to shed some 12-week labor contracts in October, following high demand in the summer when COVID-19 exposure sidelined nearly 10% of Tenet’s staff at one point, CEO Saum Sutaria said in November. He estimated two-thirds of labor cost increases came from the California and Michigan markets due to quarantine protocols.

Community Health Systems reported its third-quarter contract labor costs rose nearly 70% year-over-year to about $100 million. Still, that was an improvement from $150 million in the second quarter and $190 million in the first quarter at the Franklin, Tennessee-based system.

CFO Kevin Hammons said he expects those costs to be 40% to 50% less in 2023, a shift driven by decreased utilization and reductions in pay rates. This past year, the system also centralized its nurse recruiting team, allowing it to attract talent beyond local markets and keep better track of hiring efforts.

“We’re optimistic about 2023. We generally expect our margins to improve,” Hammons said.

For-profit system Community Health had a 1.2% operating margin in the third quarter, while Tenet, also a for-profit, reported a 8.4% margin, according to a Kaiser Family Foundation analysis.

Health systems are having to pay more to recruit and retain full-time employee, adding more pressure to their bottom lines.

Oakland, California-based Kaiser Permanente, for example, avoided a strike in November with a tentative agreement to provide more than 21,000 nurses and nurse practitioners in northern California with a 22.5% raise over four years, plus the addition of more than 2,000 positions to ease staffing shortages. As of the third quarter, Kaiser Permanente’s total operating expenses were up 5.2% year-over-year. Itreported a -0.3% operating margin in that quarter.

Limited funds

The ongoing shift to outpatient care will be a key factor affecting hospitals’ operating margins. Outpatient care may not be as profitable in some areas, but it can still provide a return, Swanson said. He expects systems to continue investing in ambulatory surgery centers or urgent care, reserving the hospitals for higher-acuity cases.

In general, outpatient care is less costly for health systems to provide, but the larger shift does put pressure on traditional hospital systems when those facilities aren’t needed as much.

Systems are also readjusting to operations without federal COVID-19 relief funds, which largely wound down in 2021, even as supply costs are staying elevated and cash on hand is dwindling at some organizations.

At the same time, health systems continue to battle with payers for higher reimbursements.

Eleven percent of claims were denied in 2022, compared with 10.2% the prior year, according to a study from professional services firm Crowe. That 11% rate would represent approximately 110,000 unpaid claims for an average-size health system. The Crowe study also found denials were valued at 2.5% of gross revenue as of August, up from 1.5% in January 2021.

More “takebacks,” or insurers’ refund requests sent to providers, are expected in the new year, as payers are once again retaining vendors enlisting groups to scour claims for overpayment after that process waned earlier in the pandemic, said Colleen Hall, managing principal of the Crowe’s healthcare services group.

“Hospitals are going to have to ensure that they are receiving every dollar that they are entitled to receive,” Hall said.

With limited funds, health systems look to generate revenue in different ways. Sacramento, California-based UC Davis Health assesses joint venture opportunities, partners with community hospitals as a transfer organization and offers subspecialty services that patients can’t find elsewhere. UC Davis also works with rehabilitation facilities to free up inpatient beds for more patients.

“Those things aren’t going to be the big bang, but we’re going to build a portfolio of things,” CFO Cheryl Sadro said.

Organizational shifts

Some healthcare organizations may have to consider structural changes if margins continue to suffer. That could include changes to care delivery, including what services to provide and the size of the workforce. Smaller, rural hospitals tend to struggle more with controlling expenses, and many are still experiencing depressed patient volumes.

Ronald Winters, co-founder and managing director at healthcare advisory firm Gibbins Advisors, which often works with smaller community hospitals, said healthcare organizations can only take cost reductions so far. They need balanced patient volumes and a favorable payer mix to improve their margins.

“If you have no flexibility on your balance sheet, you’re going to be confronted with crisis or the need to make changes quickly,” Winters said. “Making changes quickly is not easy because the biggest thing you can do is maybe reduce staffing or reduce services and staffing, which doesn’t happen immediately.”

Many independent hospitals struggle to make changes, driven by the desire to remain independent, but failure to act makes an unfavorable outcome more likely, he said.

Ultimately, a health system’s fate largely depends on what its financials looked like pre-downturn.

“Will all hospitals go bankrupt next year if they’re operating in the red? No. Some have plenty of buffer in [their] performance that they can withstand it. Some may find themselves in those positions. It really depends on your financial strength today,” Swanson said.