Thinner Margins Threaten Hospitals

January 16, 2004
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A research report detailing dwindling margins at hospitals around Michigan reinforces what chief executives and financial officers have said for some time: That finances are getting tighter and are moving closer to the breaking point for some.

The report, from the nonpartisan Citizens Research Council of Michigan, found that margins at hospitals declined steadily from 1998 to 2002, from an average of 6.3 percent to 1.1 percent.

Driving the trend was the growing contractual allowances and discounts under participating agreements with third-party payers, the economic downturn that eroded investment income and contributions, and operating costs that rose faster than revenues from patient services.

The report’s conclusion, Spectrum Health Chief Financial Officer Mike Freed said, “shouldn’t be a surprise to anybody.

“You kind of had a perfect storm going on there,” Freed said.

Spectrum Health finished its most recent fiscal year with a 1 percent margin, down from 2 percent two years earlier, according to Freed.

The trend emerged despite hospitals “doing a yeoman’s job” controlling costs during the five-year period, said Stuart Paterson, a senior research associate with the Citizens Research Council of Michigan. Rising salaries in response to the chronic shortages in the nursing, pharmacist and medical imaging professions, as well as the high cost of high-tech medical equipment, are among the major factors driving up operating costs for hospitals, Paterson said.

“They really are doing a yeoman’s job keeping expenses down, but even with that they’re getting such pressure on them in salary and technology that it’s tough to do,” Paterson said.

The organization’s report verifies the concerns of many within the health care industry over the declining financial health of hospitals. A 1 percent margin, as a net of patient revenues, is not near enough for a hospital to maintain facilities, address labor shortages, add procedures and services based on market demands, and invest in equipment upgrades to meet changing medical techniques.

“There aren’t many businesses that can stay financially viable on a 1 percent or half percent margin,” Paterson said.

The likely result is that more hospitals, particularly rural facilities, will begin dropping medical services that lose money, such as birthing units, or that don’t generate revenue, like nursing outreach programs.

David Seaman, executive vice president of the Michigan Health and Hospital Association, worries that more scenarios will unfold like the one at Detroit Medical Center, which is selling off nursing homes, closing clinics and struggling to stay afloat amid steep operating losses that are blamed on the burden of a heavy indigent and Medicaid population.

Hospitals in Michigan, Seaman pointed out, provided $1.2 billion in uncompensated care last year.

“There’s a limit to which you can draw down the capability of an institution to provide services to a community,” he said during the recent Alliance for Health First Friday Forum that offered varying perspectives on the year ahead for the health care industry.

“In some places we have reached the floor and we are nearing the floor,” he said.

Patient revenues, Seaman said, no longer are enough to cover costs of outpatient and inpatient care at many hospitals, which until recent years relied heavily on investment income and contributions to balance operating budgets.

The Citizens Research Council of Michigan report, issued in late December, shows that the 149 hospitals that were reviewed collectively saw surpluses from patient care fall from $863.1 million in 1998 to $169.7 million in 2002.

A 33.5 percent gain in patient revenue between 1998 and 2002, to $7.6 billion, was largely offset by a 60.7 percent increase, or $5.6 billion, in contractual allowances and discounts that result from growing differences between hospital charges and reimbursement payments from Medicare, Medicaid, third-party insurance carriers and managed-care organizations.           

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