Orginally published June 6th 2014, back by popular demand. – The Eds
Sometimes big game hunters find frustration when their prey moves by the time they’ve lined up to blast it. That certainly appears to be the case with the health policy target de jour: whether providers, hospital systems in particular, exert too much market power. A recent cluster of papers and policy conferences this spring have targeted the question of whether hospital mergers have contributed to inflation in health costs, and what to do about them.
Hospitals’ market power appears to be one of those frustrating moving targets. The past eighteen months have seen a spate of hospital industry layoffs by market-leading institutions, and also a string of terrible earnings releases from some of the most powerful hospital systems and “integrated delivery networks” in the country. These mediocre operating results raise questions about how much market power big hospital systems and IDNs do, in fact, exert.
The two systems everyone points to as poster children for excessive market power-California-based Sutter Health and Boston’s Partners Healthcare, both released abysmal operating results in April. Mighty Partners reported a paltry $3 million in operating income on $2.7 billion in revenues in their second (winter) quarter of FY14. Partners cited a 4.5 percent reduction in admissions and a 1.6 percent decline in outpatient visits as main drivers. Captive health insurance losses dragged down Partners’ patient care results. Sutter did even worse, losing $22 million on operations in FY13 (ended in December), — compared to a gain of $697 million in FY11 — on more than $9.6 billion in revenues. A 3 percent decline in admissions led to FY13 revenue growth of 0.9 percent (that is, nine-tenths of one percent), against 7.3 percent in expense growth.
These results were not atypical. After Sutter, the second most powerful health system in the West, Seattle-based Providence Health and Services, had $37.7 million in operating earnings in FY13 — compared to $239 million in 2011 — on $11 billion in revenues and essentially flat admissions. While some of these results were clearly affected by Providence’s take-over of the failing Swedish Health System in Seattle, there were broad declines in revenue growth across the system. Henry Ford Health System in Detroit, one of the nation’s first hospital-based integrated delivery networks, lost $12 million on operations in FY13 (before some one-time accounting changes), on $4.6 billion in revenues, and hadonly $75,000 in total system revenue growth. Expense increases of 2.6 percent effectively wiped out earnings.
Catholic giant Ascension Health reported net patient services revenue up 1 percent year over year in its Spring 2014 operations report (9mo), with a same-store 3 percent admissions decline and outpatient visits essentially flat. It was able to generate roughly a 4 percent increase in net patient services revenue per adjusted admissions (inpatient admissions adjusted for outpatient activity). Several Ascension hospitals, notably St. Vincent in Indianapolis and St. John in Detroit, had major layoffs in 2013, but the overall system generated 4 percent operating margins, down only 10 percent vs. the prior year thanks to vigorous cost cutting.
What Do These Earnings Reports Mean?
What I think they mean is that these large systems have been unable to offset declines in utilization and Medicare funding reductions by cost shifting to private insurers. According to the Bureau of Labor Statistics, overall hospital pricing growth has gradually declined for a decade into the low single digits. One is dying to know the dispersion around this declining mean, and how this chart looks in highly concentrated markets like Boston and San Francisco. If hospital industry consolidation, which accelerated after 2008, is “helping” hospital pricing, it isn’t obvious from this chart.
Producer Price Index, Hospital Component
Source: BLS
I think the soft rate controls contained in the ACA, including the de facto 10 percent cap on health insurance rate increases imposed by CMS, and the threatened exclusion of plans that raise their rates by more than the cap from the ACA’s Exchanges, may have toughened the rate negotiating posture of health plans with their hospital networks. A number of large national health plans missed their earnings targets in the 4th Quarter of 2013, according to CitiGroup’s health insurance analyst, Carl McDonald. These earnings misses will undoubtedly result in continued pressure on rate negotiations between hospitals and insurers. If the cost surge some analysts saw early in 2014 continues, the rate negotiations this summer and fall for next year will be bloody.
Effects of Consolidation and Market Power
If one looked at FY11 operating results for the health systems above, one would have drawn a completely different conclusion about the effects of industry consolidation, as many large health systems generated record operating earnings in that year. Did their leverage completely disappear in the succeeding two years? Probably not. Higher contracted price increases to the large regional hospital systems may have been “financed” by minimal or non-existent increases to the marginal hospital players, rather than being passed on to the ultimate employer customer, explaining the overall pricing trend in the above chart. But it does appear that double-digit rate increases for big hospital systems have taken a holiday.
Conspiracy-minded observers might theorize that the political pressure on the big systems has encouraged them to “lie low” for a couple of years to let the pressure for regulatory solutions subside. Generally, I don’t believe in conspiracies; they are too much trouble to pull off. Rather, I believe that the negotiating climate between systems and health plans has actually materially toughened. A more plausible explanation for some big systems’ mediocre operating results is that a few really good years led to laxity on the cost control side, requiring health system managers to refocus on efficiency and quality, as indeed Ascension did. The only way to know for sure is to be patient and let the market reveal itself to us.
The policy challenges created by disinflation are different than those required by hyperinflation. Multiple years of aggressive rate increases by large systems has likely left behind very significant pricing gaps between large and small players in many markets — a source of great vulnerability for these systems in an era of rising cost sharing, etc.
This means that reference pricing strategies that reward consumers for selecting high value providers for certain procedures (imaging, arthroscopy, cardiac care, etc.) – which were discussed in Paul Ginsburg and Gregory Pawlson’s recent paper and advocated by the large self-funded employer collaborative Catalyst for Payment Reform — could have a major effect of shifting volume to more efficient, or less aggressively priced, smaller players, including physician sponsored surgical and imaging providers.
Bruce Vladek expressed doubts about consumers’ ability to exert, or interest in exerting, purchasing power. He’s at least partially right. Consumers of health care are not always price-motivated shoppers and are not capable of exerting influence on the non-elective care hospitals provide. But consumers don’t have to pressure prices across the entire spectrum of hospital services to profoundly affect hospitals’ earnings; moving volume for the highly profitable elective services like imaging and surgery (inpatient and outpatient) will have an outsized impact. Reference pricing should concentrate on this type of elective care that multiple providers, including physician groups and networks, might offer.
The current disinflationary pricing environment for hospitals raises a lot of questions about the need for hospital rate controls or other permanent regulatory remedies amenable to capture by powerful hospital interests. It is possible that a resurgence of cost inflation will lead yet again to outsized rate increases for the most powerful players in local hospital markets. But permanent and rigid solutions to cyclical problems probably aren’t good policy.
Health insurers and employers will certainly need to keep the pressure on their provider networks. But it is clear that the most reliable source of future earnings for these powerful health systems will be in squeezing waste out of their staffing and care processes, and actually finding the elusive “economies of scale” the consultants and bankers have talked about for the past thirty years. Ultimately, as I’vesuggested elsewhere, creating measurable value for the ultimate customer of health care, patients, and their families, is the most reliable and defensible source of future earnings growth.
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Health care spending is an expense to some and an economic driver to others. This migration to a more efficient and cost effective hospital system should be executed very deliberately so as to shift dollars and resources in a manner which will not cause severe disruption to those areas whose economies rely heavily on health care jobs.
My health economics classes have discussed this possibility of moving away from complete reliance on user fees in favor of fixed annual budgets for some elements of hospital operations, e.g., emergency medicine. There is an overall public benefit associated with access to emergency care as part of a broader emergency/public health preparedness strategy where “sufficient” capacity goes beyond what day to day normal ER user fees would require.
Several of the big systems in trouble-Providence in Seattle, Wake Forest Baptist- blame their Epic implementations for damaging their revenue cycle and adding costs. But in both cases, the underlying financial problems go back years. This wasn’t driven by HITECH, but by a wave of imitation, and presumed long term benefits that require short term sacrifice- and for some reason don’t materialize later. . .
Dissociate health insurance from employers, incentivizing patients to care about prices, and you would see prices drop like a rock from manufacturers to suppliers to hospitals, and many business failures. It would be painful for the economy for awhile, but then this industry would normalize to the standard of other industries.
How much of this ‘decrease’ in market power could be attributed to HITECH and increased in investments in EHRs to reach meaningful use? There are many costs associated with the transition to an EHR. And as health systems consolidate, the newly acquired hospitals require investments to upgrade and integrate.
Note to Jeff:
In this instance I would not dump on the VA. Many of the awful delays occurred in just a few areas of the country. Many of the delays were for doctor’s appointments and not for urgent care. (see articles by Philp Longman, Don McCanne, and others. I attended to my father at the Minnesapolis VA hosptial for a year and his care was superb.
Besides, no VA hospital ever drove a patient toward bankruptcy. That is something to consider in a final judgement.
It is of course a given that administrator salaries should especially be cut along with other salaries.
I am more familiar with the financial situation of Partners Healthcare than with Sutter Health. Partners has a pricing premium over other hospitals starting in 1994 when the two most prestigious hospitals in Boston, Mass General and Brigham & Women’s, were allowed to become Partners Healthcare. The reason was to prevent health plans of negotiating one prestigious hospital against the other.
When profitable has been a problem for Intel the firm has on more than one occasion cut wages by 10%. Airlines, also, have renegotiated wages with their employees. SEIU is a very strong union and I expect that wages of nurses, techs, and employed physicians should be cut, at least in Boston, New York, and much of California, where these wages are very high.
So you think we ought to run them like the VA?
I suppose that Dr Robert Evans of Canada has retired by now. But it would be great to have him back.
Beginning in the 1980’s, he made the point over and over again that we do not need to fund hospitals only through user fees.
When you rely on user fees, and the number of user fees go down, then you have no choice but to raise user fees. At some point the poor car crash victim, who has no choice about their care, will be charged $200,000 for 4 days of care.
Seems to me that hospitals could enter their own kind of death spiral, until we start to fund them like fire and police departments, i.e. through municipal and federal taxes.
This will be tremendously hard to do. At first, insurance premiums will not go down at all, so the average citizen could be paying higher taxes and high insurance premiums.
But I do think that the user-fee model must be questioned. Americans by and large have what I consider the strange idea that hospitals should be self-financing through patient charges.
I have it on good word from a source at a prominent integrated healthcare entity that their strategy is to reduce rates by about 12% across the board and one time and then hope to start increasing them again after certain upcoming political events. There have been discussions directly between the White House, CMS, and C-suite. So yeah, “staying low” is definitely an option in some places.
Thanks, Jeff. Useful thoughts.
HCA has actually grown its admissions, and because of where they located their hospital assets, never really got hurt by the recession (!). I’ve been working on a blog posting about what they’ve done. They’ve been very disciplined and focussed.
Tenet and Community, for different reasons, had great exposure to the downturn, and a ton of no-pay and Medicaid. So they’ve benefited disproportionately from ACA’s coverage expansion. Tenet has two very large urban care systems (Detroit and San Antonio) from Vanguard and was seriously exposed to Florida/Arizona/Southern California downturn. Even though a lot of Tenet’s states declined to expand Medicaid, the non-expanding states have still added a million Medicaid enrollees thru the federal exchange (people who were previously eligible). It’s been a big help, but the financial effect is still quite modest. The recovery has been a much bigger help than ACA has.
Don’t think the non-profits have figured out how to avoid bad debt folks, or some magic way to collect from them. The collection rate on hospital debt is REALLY low. Remember also that many of the most successful non-profit chains (Providence, Ascension, CHI, etc) have religious sponsorship that is sensitive to community mission which makes caring for the poor important. They cannot just walk away.
As I alluded to in my posting, their big problem has been inattention to cost and perhaps overestimating how much leverage they have with the big payers in their markets. Their overhead is still way too high, and they have too many administrative folks sitting in meetings and not enough people on the front lines. Ascension is, according to what I hear on the street, taking out 12 thousand positions, and was the first to aggressively attack their overhead. It won’t take them long to adjust.
The biggest problem all these hospital systems face is that half the country cannot afford to use their products without massive public subsidy, and those public subsidies come with a lot of alligators attached to them. The biggest reason for the recession in healthcare: people don’t have the cash to pay the patient portion of the costs, and have stopped using the hospital unless it’s literally life threatening.
The compare/contrast between these systems and the for-profit systems benefiting from bad debt reduction under ACA ( see http://www.nasdaq.com/article/the-168-billion-obamacare-windfall-many-hospitals-are-missing-cm380843) is amazing. It suggests that Sutter and Providence had already succeeded in getting rid of “bad debtor” patients in a way HCA had not been able to do! Or am I being too cynical?
In any event, this may be the most important story playing out in US health care right now.
According to actuaries at Milliman network pricing is the key to lower premiums
Those with lower network pricing assuming the network also provides quantity and quality of providers will capture a significant share of the business each year it holds those advantages
While annual premiums are lower how much lower can they be even for the Blues – ten percent or twenty percent
The more effective and less time consuming way for people to lower their premiums is by prefunding the deductibles from an insurer providing 35 percent returns on their prefunded premiums
For whether the insurer is large or small if one prefunds his deductible to $25,000 his premium is reduced 55 petcent and to $50,000 by 70 percent
Don Levit
All of these systems saw negative hospital admissions and essentially flatline or 1-2% positive outpatient growth. The hospitals that have been helped by ACA so far have seen reductions in bad debts and improvements in their payor mix (e.g. less uninsured and more Medicaid) but not much volume.
This isn’t surprising. ACA will pump a grand total of $40 billion into a $2.8 trillion health system in federal FY14, which ends next month, a homeopathic level of funding. This a little more than doubles in FY15 to $90 billion. If hospitals get, say, 40% of that, that’s $16 billion, then $36 billion for a $900 billion industry. They’ve already given up way more than that in Medicare funding reductions so far, so I don’t think the industry reaches positive cash flow from ACA until 2016 or later.
And since half the newly covered (e.g. the Exchange folks) will have huge deductibles for hospital care, I’ve never expected to see much of a surge in hospital utilization, except in the ERs.
Excellent analysis. Very interesting stuff. The first-quarter earnings of the big players are especially interesting given that this was the first quarter of the ACA’s full implementation. I would love to see their volume numbers. I doubt there was that much of a surge. The newly insured are actively discouraged from using their new plans by the relatively high deductibles, co-pays, and co-insurance, so except for really big problem, they are likely to act as if they are still uninsured. But whether those major systems saw any surge in volume or not, they were clearly unable to profit from it.
Thanks for the analysis. I look forward to your paper next month.