Hospitals need ‘transformational change’ to stem margin erosion

Diving brief:

  • Nonprofit hospitals are reporting thinner margins this year, strained by rising labor, procurement and capital costs, and will be pressured to make big changes to their business models or risk negative rating stocks, Fitch Ratings said in a report on Tuesday.
  • Warning that it could take years for supplier margins to return to pre-pandemic levels, Fitch outlined a series of steps needed to manage inflationary pressures. These measures include larger rate increases in the short term and “relentless and continued cost reductions and productivity improvements” in the medium term, the rating agency said.
  • Further on the horizon, “improving operating margins from reduced levels will require hospitals to make transformational changes to the business model,” Fitch warned.

Overview of the dive:

It’s been a tough year so far for U.S. hospitals, which are dealing with labor shortages, rising operating costs and a rebound in healthcare utilization that followed the suppressed demand from the start of the pandemic.

Pressure on operations has resulted in five straight months of negative margins for health systems, according to the latest Kaufman Hall Hospital Performance Report.

Fitch said the majority of the hospitals it tracks have strong balance sheets that will provide a cushion for some time. But with cost inflation at levels not seen since the late 1970s and early 1980s, and the potential for additional coronavirus outbreaks this fall and winter, more substantial changes to hospital business models may be necessary to avoid negative rating actions, the agency said.

Suppliers will seek much higher rate increases from commercial payers. However, insurers are facing similar pressures to hospitals and will push back, using the leverage gained from industry consolidation, the report said.

As a result, rate increases from commercial insurers are expected to exceed those in recent years, but remain below the rate of near-term inflation, Fitch said. In addition, federal budget deficits make adjustments to Medicare or Medicaid rates to offset inflation unlikely.

A first look at state regulatory filings this summer suggests that insurers offering plans on Affordable Care Act exchanges will seek to significantly increase premiums in 2023, according to analysis by the Kaiser Family Foundation. The median rate increase requested by 72 ACA insurers was 10% in the KFF study.

Inflation is pushing more suppliers to consider mergers and acquisitions to create economies of scale, Fitch said. But regulators are looking at the deals more closely amid fears consolidation could push prices even higher. With rising capital costs, rising interest rates and continued supply chain disruptions, plans to expand or renovate hospitals will cost more or could be postponed, according to the report.