“In preparing for battle I have always found that plans are useless, but planning is indispensable.” This quote attributed to Dwight Eisenhower is good advice for strategizing in an environment where one knows that the conditions will change. Such is the case with the future of revenue for health care providers in America.
U.S. health care is a $2.9 trillion complex and adaptive system of entities including insurance companies, hospitals, pharmaceutical companies, medical equipment manufacturers, technology companies and increasingly more stakeholders. Until recent years, the federal government had largely been a reactive participant since the advent of Medicare. For many Americans, the system has worked relatively well, with the average consumer enjoying access to quality care, state-of-the-art technology and a fair amount of options. However, the Medicare system has some glaring flaws that make it unsustainable as the population ages. The primary flaws include the unacceptably large percentage of the population without insurance and costs growing much faster than the rate of overall inflation, which led to the adoption of the Patient Protection and Affordable Care Act (ACA).
While the ACA aimed to accomplish several things, perhaps the single biggest long-term change was the creation of the Center for Medicare and Medicaid Innovation (CMMI). CMMI is intended to drive changes through new payment models and performance metrics. Currently, CMMI is testing innovative payment and delivery system models that show important promise for maintaining or improving the quality of care in Medicare, Medicaid and the Children's Health Insurance Program (CHIP), while slowing the rate of growth in program costs.1 In order to prepare for the impending changes, a hospital’s management and board should carefully reconsider its organization’s mission and role in the community.
The New Health Care Paradigm – Incentives Matter
Historically, hospitals in the United States were paid on a fee-for-service (FFS) model. While this method has some merit, it can create perverse incentives. The new paradigm, called “triple aim,” seeks to better align incentives through improving the patient experience of care (including quality and satisfaction), improving the health of populations and reducing the per capita cost of health care.
None of these goals are controversial, but there exists a major challenge in getting the various stakeholders to coordinate in achieving these goals. At best, many of the key players have worked independently to form a high-quality and cost-effective system. Often, entities have battled over revenue arrangement such that health of populations’ vis-à-vis access is compromised.
Recognizing the incentive problems with FFS, CMMI is pushing a number of models that will challenge all participants in the American health care system. The biggest change is a shift to value-based reimbursement, which is a search for better health outcomes at a lower cost. According to Standard and Poor’s (S&P) Rating Service, “it's probably the single most significant factor now fueling health care reform.” In a fee-for-value system, the emphasis changes to paying providers for stronger preventive care and early detection, instead of paying them to treat an illness through episodic care, as they would under FFS models.2 This shift is still in its infancy, as the majority of reimbursement remains in a FFS model. Consequently, creditors and financial analysts have to look beyond historical financial statements to determine if a particular organization is set-up to handle the future.
Medicaid Expansion and the Power of Technology
The most widely reported aspect of the ACA is the expansion of insurance to millions of Americans. Partly through insurance exchanges, over 11 million more people now have insurance. While this is an unalloyed positive development in achievement of the “triple aim”, the expansion brings new challenges. Medicaid is the primary source of reimbursement for the newly insured and it is generally considered to be an inferior payor source. Many physician groups do not accept Medicaid; thus, patients wind up visiting the local emergency room (ER) for care. ERs in many communities were already stressed, and the influx of new patients has further stretched the resources at many facilities.
Creditors and financial analysts recognize the potential benefits of more efficient facilities, including the potential for additional admissions or procedures at the hospital. However, the temptation to expand must be tempered by the risk incurred by overleveraging a hospital’s balance sheet. Carrying too much debt can make a hospital’s credit profile too fragile in an uncertain environment.
Perhaps the biggest opportunity and greatest challenge facing health care providers is the use of technology. Technological improvements are nothing new, of course, but a government mandate for Electronic Health Records (EHR), along with market demands to improve efficiency and accuracy, make this area a paramount strategic and operational focus for every organization. The promise of a well-executed IT strategy is better population health, with more accurate and complete data, more efficient billing and reduced cost. The difficulty is often in the implementation, as a lack of resources and poor training can lead to delayed projects and an unwillingness to embrace the full power of innovation. From an analytical point of view, some important questions are: does a hospital have a reasonable plan for integrating technological systems? And what has been its recent experience with major projects? Often, the answers are disappointing, which ties into another major consideration for all health care providers—affiliation.
M&A – Strength in Numbers
Mergers and acquisitions (M&A) and affiliation agreements are a dominant theme for financial analysts. It is generally understood that the health care delivery system has to be more efficient. The improved use of technology is one aspect of the operational efficiency that ties in with value or risk-based health plans. Through the use of “big data,” insurers and government payors have a much better means to track population health and pinpoint costs. In addition, affiliations or business combinations offer an opportunity to, “bolster scale, scope and diversify; boost profitability; enter new markets; and enhance their competitiveness.”3
From an analytical and creditor’s perspective, it is crucial that organizations clearly articulate the current and future states of their affiliation strategy. For some providers, the only viable option may be a merger. Many health care systems have expanded through horizontal integration by the acquisition of other health care operations, in addition to combinations with strategically targeted hospitals. Generally, from an analyst or creditor’s point of view, the fewer providers in a market the better. Fewer providers leads to better buyer power when negotiating with payors and vendors. For now, independent hospitals can survive, but it will be increasingly difficult to manage the health of a population without being part of an integrated network of providers.
Putting it All Together
Improving the overall wellness of the population is the main goal of stakeholders in the health care system. Physicians and hospitals are on the front line in the effort to improve access, while at the same time reducing cost and improving the patient experience. A welcome change in recent years is the push for community programs designed to better educate the population regarding health issues. It is important for providers to identify and describe initiatives to improve the wellness in their community. While risk-based payment programs represent a very small proportion of the payment plans now (less than 5%), it is undeniable that payments tied to health of a population are a growing force.
The challenges mentioned in this article and the context where market driven reforms dovetail (or sometimes collide) with regulatory changes can be daunting. Until recently, it was generally accepted for hospital management to respond with a blithe dismissal when asked about the impact of reform. No longer can a hospital board or management get by with vague assurances to questions about planning for a vastly different payment structure.
For now, rating agencies and financial analysts continue to examine the historical operating performance of a health care organization. Debt service coverage, cash to debt and operating margins are still important. However, the examination goes deeper with an increased focus on underlying metrics (ie: FTEs per occupied bed) that provide signals of operating efficiency. The market-driven and government mandated reforms will place increasing pressure on operating costs.
While operating efficiency is the most important piece of the puzzle, creditors and analysts are placing a greater emphasis on the strength of hospital boards and management. Importantly, hospitals need to understand that a complex adaptive system cannot be predicted, so risk management is difficult. Organizations that can adapt by implementing robust processes and systems will have the best chance to survive and thrive.
Hearkening back to the Eisenhower quote, creditors and analysts are more interested in seeing that an organization is planning than knowing the details of the plan. Key questions are: how is the organization set up for value and risk based reimbursement? What is the organization’s affiliation plan? What is the organization’s track record and plan for implementing new technology? And what is the organization doing to connect to its community? Organizations that can demonstrate a thorough and consistent examination of these questions will be well-prepared for the future.
1. Guterman S, Davis K, Stremikis K, Drake H (June 2010). "Innovation in Medicare and Medicaid will be central to health reform's success".
2. Standard & Poor’s Rating Services, (July 20, 2015) “As The ACA Takes Hold, Health Industry Outlooks Are Mostly Stable, But Not The Health Care Landscape”.
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Bruce Lorenz, Chair