September 19, 2018

A new report throws into question the common wisdom that scale enhances health system operations. The study, by consulting firm Navigant, found no correlation between higher revenues and better operating margins among 104 highly rated hospital systems during 2015-2017, following the expansion in insurance coverage that accompanied the Affordable Care Act (ACA).

The findings debunk a widely held belief within the sector that has catalyzed heightened merger and acquisition activity in the past several years. Many healthcare organizations have assumed that the current highly competitive healthcare environment requires an increase in size to drive cost efficiency, better care coordination across the continuum, physician recruitment and retention, reduced risk and other benefits in order to succeed. The report counters this widespread thinking, revealing “no relationship at all between profitability and the size of the system,” according to Jeff Goldsmith, a principal author of the report, in an interview in Modern Healthcare.

Researchers reviewed the audited financial reports of 104 leading health systems, which operate approximately 47 percent (2,289) of community hospitals; extracted operating income and operating revenues for fiscal years 2015, 2016 and 2017; and analyzed trends in operating margins, both for individual systems and geographic regions of the United States.

Two-thirds of the health systems experienced operating income decreases during the three-year period covered in the report. Overall, health system operating margins declined by 38.7 percent, with non-profit system margins decreasing by 34 percent and for-profit system margins dropping by 39 percent.  More than a one-fourth of the systems experienced operational losses in at least one of the three years, and 11 percent experienced negative margins throughout the timeframe.

Other major findings in the report:

• Twenty-two of the health systems experienced operating income declines of more than 100 million dollars each during the three years.
• Significant regional differences in operating margin changes were found, with the largest operating income drops taking place in the West/Southwest and South Central regions.  These regions are also the most quickly growing areas of the U.S.
• The declines were spurred by multiyear reductions in topline operating revenue growth, which decreased from seven percent in 2015-2016 to 5.5 percent in 2016-2017.  Among the factors driving these declines were reduced demand for core hospital services, such as surgery; reductions in collection rates from patients in states that opted out of the Medicaid expansion that was a cornerstone of the ACA; erosion in Medicare payment rates; and failure of value-based contracts to yield sufficient patient volume to offset payer discounts and investments by hospitals in population health management.

The findings of the analysis “should compel health system management teams and boards to re-examine their assumptions about the future direction of their markets and organizations,” Mr. Goldsmith and his co-authors conclude. The current economic expansion in the U.S. “will not continue indefinitely,” and “when it is over, those who pay for care will place renewed pressure on the care system by pressuring rates and shifting more of the cost onto consumers, many of whom are unable to pay the patient share.”

Moreover, the authors assert that health systems cannot count on their investment portfolios to offset declines in their operating income, but instead, must look closely at their markets, and size and target services to mirror actual demand.  They must also demand improvements in efficiency and effectiveness in their asset portfolios and in the value of their services, most notably for their patients.

Ideally, they note, healthcare organizations would have accomplished much of this recalibration five years ago, but since they have not, time is of the essence.