How Hospitals in the Southeast Can Plan a More Secure Financial Future

How Hospitals in the Southeast Can Plan a More Secure Financial Future
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Here’s what hospital systems in the southeast can do to prepare for the year ahead.

Key takeaways for hospital executives:

  • Make sure your investment portfolio is correctly allocated, as the market’s dramatic fall and then rise may require some rebalancing.
  • Check your liquidity ratios and fine-tune your lines of credit, including opening new lines if needed.
  • Decide if it’s a good time to issue taxable or tax-free debt.
  • Consider your long-term care model and whether merging with a peer institution or network or expanding care options may make sense for you.

While the U.S. is hoping the pandemic might begin to simmer down by mid-2021, experts say that hospitals can expect the bumpy financial road they’ve been on to continue long past the rollout of the COVID-19 vaccine. This means that hospital executives will have to get creative about fixing inefficiencies and shoring up liquidity for more uncertain times ahead.

The pandemic has devastated hospital finances. In Florida alone, hospitals reported in August that they collectively lost nearly $4 billion over four months as COVID-19 ravaged normal operating procedures. And that was before the second surge of fall and winter.

“Our clients were all impacted, some more so than others,” says Michael Thomas, Director of Healthcare Analytics at Highland Associates.

For now, hospital systems that have their own insurance plans are holding up better financially than those without, and integrated networks that have scale are outperforming smaller hospitals on financial metrics. But Thomas predicts it will be late 2021 before things start to go back to normal in the health care industry. This is in spite of the fact that the Biden administration’s stated intentions to grow access to care and expand the Affordable Care Act should give more Americans access to insurance coverage, easing some of the burden for hospitals.

For hospital executives, it will be important to be fully prepared for the year ahead, an exercise more complex than usual given the tumult of the last year. Planning should take into account immediate financial concerns driven by the pandemic, as well as persistent longer-term trends in care models and hospital financing.

Recovering From a Turbulent Year

The COVID-19 pandemic hit hospitals on two fronts: investments and operations. As lockdowns swept the U.S. in March 2020, upheaval in the capital markets saw equities down globally. Hospital investment portfolios were impacted significantly — a major issue for not-for-profit hospitals, for which investments are usually the largest asset. A hospital’s portfolio figures into liquidity calculations — crucial measures of solvency — and ratings agencies use these figures to calibrate debt ratings, which in turn help determine how much a hospital has to pay to borrow money.

On the operations front, hospitals ran into trouble this spring, and again in the fall, when lockdowns, local restrictions, and surging cases forced them to suspend lucrative elective procedures to make room for COVID-19 inpatients. The beginning of the pandemic took a particularly hard toll on operations: According to Thomas, hospital operating revenues were down 25-50%, and operating margins fell 35% across the not-for-profit health care universe. And while the CARES Act provided a measure of relief by infusing liquidity, operating margins were still down 13% after the legislation went into effect.

At the same time, hospitals’ expenses rose dramatically due to extra pandemic-related costs. Hospital administrators needed to spend heavily on personal protective equipment (PPE) to meet the first-wave surge in patients. Cleaning supplies, ventilators, and protective gear for doctors, nurses, janitorial workers, and security staffers were all on hospitals’ emergency procurement lists. And in pandemic hotspots across the U.S., hasty construction projects sprang up as hospitals rushed to alter wards to safely accommodate COVID-19 patients. Increased staffing needs, particularly the use of contract nurses during peaks, also contributed to higher costs.

After the Federal stimulus legislation went into effect, the associated rebound in investment markets helped many hospitals climb out of this financial pit. By November, the markets were positive on the year, providing some breathing room for hospitals’ investment portfolios. “More than $50 billion in CARES Act funding provided temporary relief, helping to push May’s median hospital operating margin to 4%,” up from the negative 8% margin that hospitals would have notched without the funding, wrote research firm Kaufman Hall in the June 2020 edition of its National Hospital Flash Report.

However, the waves of COVID-19 patients and pandemic restrictions continued to squeeze hospital revenues. Even after elective procedures resumed, cautious patients continued to cancel appointments and elective procedures, and in many places, elective procedures were banned again in the fall.

Liquidity Remains Paramount

With things not quite back to normal, where does that leave hospitals in the southeast, particularly when it comes to longer-term financial planning? According to Thomas, forward-looking hospital systems are using the financial assault that COVID-19 brought as a catalyst for future planning.

There are several financial fixes that hospital executives could be thinking about right now. Each situation is different and constrained by unique local factors. However, the most important step will be to bolster liquidity. For many hospitals in the southeast, cash is the difference between being able to fulfill their mission and closing suddenly.

First, take a look at your investment portfolio and make sure it’s correctly allocated: Thomas notes that the market’s dramatic fall and then rise may require some rebalancing. A well-balanced portfolio brings financial flexibility if the need for liquidity arises.

Next, consider credit. Thomas notes that many hospitals expanded their access to lines of credit in March. Some CFOs and treasurers established new lines of credit to help subsidize operational shortfalls if needed.

Lines of credit have a couple of advantages over other liquidity sources right now. First, even with the rebound in the markets, the ability to borrow through a line of credit is a more flexible option for hospitals than selling off part of a long-term investment portfolio. Plus, Thomas notes that with today’s ultra-low interest rates — and the Fed’s promise that rates will not rise in the short term — lines of credit remain a logical choice.

“A lot of our clients are not drawing on those lines at this time,” explains Thomas. “They're a potential source of liquidity, particularly for hospitals who were worried they may have to potentially subsidize operations.” For those with the ability, persistent low interest rates also make it attractive for hospitals to issue either taxable or tax-exempt debt.

When adding more liquidity, Thomas advises hospitals to track their liquidity metrics. In this industry, the most important metric is days of cash on hand, which ratings agencies watch closely. A single-A rated hospital, for example, should have 150 days of cash on hand, while a double-A institution should have 250 days cash on hand. If you fall below that level, your hospital risks a ratings downgrade, which can affect future access to debt funding as well as interest rates.

He notes that another way hospitals might stretch their cash cushion is to look for inefficiencies in operations. For many, cutting expenses where possible is often the only method of shoring up hospital cash flow during this time. After all, it’s difficult to raise revenues without the necessary patient volumes, which may not return to normal for some time. “There’s not much you can do on the revenue side if procedures are suspended or if people aren’t going to come to the hospital,” Thomas explains.

Evaluating Your Care Model

During this time, it’s also a good idea for hospitals to examine their care model to make sure it matches up to this economic environment. The pandemic has accelerated the adoption of certain care models, such as telehealth, which has been around for years but saw adoption accelerate during the pandemic thanks to emergency changes in insurance reimbursement rules as well as safety concerns about in-person care.

Rethinking telehealth

Although most providers and patients would prefer in-person visits, this crisis has made it clear that telehealth has some advantages, like giving patients access to a wider selection of doctors, without geographic limitations. Not only are virtual visits easier for elderly patients and for those with mobility issues, but following the closure of 134 rural hospitals over the last decade — many of which were located in the southeast — telehealth might also be the key to addressing this region’s growing health care deserts.

The question for hospital executives is whether telehealth can be made profitable, and whether video visits will erode some inpatient care, which often provides higher margins for hospitals.

How telehealth fits into the continuum of care in a post-pandemic world will also depend on whether the government and insurance companies continue to reimburse for it.

“If not, it will be more difficult for hospitals to operate in an environment where care is being delivered virtually or in outpatient settings,” Thomas explains.

Expanding outpatient care

Many hospital networks have ambulatory service centers (ACS) for routine surgeries, which are generally cheaper for the patient than inpatient facilities, although the health care organization sees lower margins. Adoption of these centers has surged in recent years: ACSs performed more than half of all outpatient surgeries in 2017, up from 32% in 2005, according to Bain & Co.

Government insurance plans now prefer knee replacements, for instance, to be done as outpatient procedures and commercial insurers will likely follow suit. According to Thomas, a larger proportion of hospitals’ borrowing over the last five years has gone to finance outpatient centers compared to traditional large inpatient towers. This trend is expected to continue as hospitals build more outpatient facilities to capture revenues from procedures that once were done inpatient, but now no longer include an overnight hospital stay. Through the expansion of outpatient offerings, hospitals are well-positioned to capture a greater share of value-based contracts and incentives.

Exploring M&A

Hospitals can also grow through mergers and acquisitions, an increasingly popular path for health care organizations across the care spectrum. Although not-for-profit hospitals may have difficulty taking on strategic investments, larger hospital systems today are often looking for increased scale. This can be accomplished by moving into another geographic area or by acquiring another hospital or health care facility. According to Thomas, Vanderbilt University Medical Center is one example of a not-for-profit hospital system that has grown through partnerships with other facilities outside of its home base of Nashville.

Mergers and acquisitions can make sense for groups hoping to seek scale in a bid to gain revenue synergies and streamline their operations. Ultimately, they can enable hospitals to treat a patient not just for one episode of care, but for a lifetime. Not only does this often lead to better patient outcomes, but the hospital itself may save money thanks to a decrease in avoidable complications and hospital readmissions. Ultimately, there are both pros and cons to health care mergers and acquisitions, and it may not be the appropriate growth move for every hospital.

As the pandemic winds down, the centrality of health care as an essential service will remain at the forefront of the public’s mind. Take this opportunity to make sure your hospital will be there for your community when it needs you — in crisis and every day.

Regions’ dedicated Healthcare Group brings deep industry knowledge, experience, insight, and understanding to support our clients’ growth and development. Visit our website to connect directly with one of our healthcare bankers.

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