Hospitals in Distress: How the Economy has Affected Financing of Health Care

by Marianna Kiselev March 16 2010, 21:34

I.  Introduction

In the current financial crisis borrowers are finding it increasingly more difficult to access capital for their investments.  This is affecting one of the most important industries in our society, heath care.  Hospitals are a vital part of the health care industry and they are facing especially hard times in today’s economy.  It is not a surprise to many people that hospitals are facing financial difficulties.  Hospitals have consistently faced financial difficulties even in a good economy.  However, the current credit crisis is affecting hospitals more than any other organization because of the high levels of uninsured seeking health care services, low reimbursement rates from Medicaid and Medicare, and staff shortages.[1]  Now more than ever before hospitals are facing increasing debt and are unable to gain more capital or refinancing their existing loans because it is more difficult to obtain credit.[2]  As a result, hospitals all over the country are filing bankruptcy and some even closing down.[3]  Why are hospitals more vulnerable in the current economic crisis than other organizations?  Why are some hospitals successful in the current economy and others unable to stay open?  What can be done about this?  What implications does this have on the health care system?  This article will identify some of the reasons why hospitals are facing financial difficulties and propose possible solutions to help hospitals become financially stronger.   Specifically, Part II generally outlines how hospitals are financed.  Part III considers a myriad of issues that are causing hospitals to suffer financially in the current economy.  Part IV presents solutions to the problems faced by hospitals, specifically drawing upon examples of hospitals that are able to generate a healthy operating margin.  Part V concludes by urging hospitals and the government to start taking serious steps to fix this problem because hospital closures may have a devastating effect on the ability of Americans to access health care.

 

 II. Hospital financing   

 

In order to measure a hospitals financial viability there are several factors to consider.  First, it is necessary to identify how a hospital generates its revenue.  There are several sources of revenue for hospitals which include but are not limited to revenue for providing medical services, revenue for providing nonmedical services, investments, and donations and grants from individuals, foundations, and the government.[4]  Operating revenue, or income earned by delivering patient services, is the primary way that hospitals generate revenue.[5]  Hospitals rely directly on the patient or third party payers for reimbursement for their services.[6]  Often times third party payers are responsible for reimbursement and therefore the payment collection process can be complicated, time consuming, and expensive process.[7]  Furthermore, the reimbursement for health care services will vary greatly depending on the third party payer.[8]  Third party payers may include private insurance companies, health maintenance organizations, and government entities such Medicaid and Medicare.  The reimbursement rate and the how long it may take to get the reimbursement will depend on the third party payer.

 

Second, it is necessary to identify hospital expenses.  The majority of hospital expenses result from wages and salaries paid to employees.[9]  Other expenses include supplies, depreciation, interest payments, and bad debt.[10]  Bad debt is the charges the hospital expects to collect for the services but for which it does not receive payment.   

Hospital revenue and expenses are used to calculate the operating margin.  The operating margin measures the “hospitals profitability, before taxes, and reflects a hospitals ability to sustain and grow its business in the future.”[11]  This is measured generally by comparing the hospitals total operating revenue against its total operating expense.[12]  A healthy operating margin for a hospital is 3 to 5 percent.[13] A negative operating margin means that the hospitals operating revenue is less than the operating expenses.[14]  A recent study of hospitals in 28 states indicates that more than half of them reported negative operating margins.[15]  This indicates that the declining economy is having a drastic effect on hospitals.[16] 

  

III. Why hospitals are facing financial difficulties and how that has increased in today’s poor economy

 

There are many reasons why hospitals are facing financial difficulties and considering closing down.  The large organizational structure in hospitals often makes it difficult to isolate just a few factors responsible for hospitals poor financial health.  This paper will attempt to isolate the factors that have had the most impact recently and that are the most vulnerable to changes.  

 

A.   Low reimbursement rates

 

Reimbursement rates from Medicaid and Medicare have fallen which has put a significant financial burden on hospitals.  A recent study done by the American Hospital Association indicates a steady rise in the amount of underpayments for both Medicare and Medicaid.[17]  Underpayments are defined as “the difference between the costs incurred and the reimbursements received for delivering care to patients.”[18]  The underpayments for Medicaid and Medicare have increased from 3.8 billion in 2000 to 32 billion in 2008.  As a result of low reimbursements hospitals are having to cost-shift which results in an increase in the price of supplies and services.

Reimbursement rates for Medicaid are dependant on state budgets and often take a long time to obtain and are fairly low.[19]  The American Hospital Association reported that hospitals received payment of 88 cents for every dollar spent treating Medicaid patients.[20] In addition, as the economy is declining the amount of people eligible for Medicaid is increasing.[21]  An American Hospital Association report indicated that hospitals have reported a “forty- six percent increase in the proportion of patients covered by Medicaid or other public programs.”[22]  This will results in higher state deficits and lower reimbursement rates.

 

Alexian Brothers Medical Center in Illinois like many hospitals is affected by Medicaid’s low reimbursement rates.  Less than 12% of hospital’s patients are covered by Medicaid.[23]  While this may not be as high as other hospitals it still requires the hospital to cost-shift in order to make up for the amount that is not reimbursed.[24]  In addition, in Illinois there has not been a Medicaid inpatient rate increase since 1995.[25]  The high deficit in Illinois as well as in other states is having an impact on hospitals financially.  

Medicare reimbursement rates are higher but still present a financial obstacle for many hospitals.  The Medicare Hospital Trust Fund has reported that it will cover only 78% of hospital services.[26]  In addition, many hospitals see a higher percentage of Medicare patients.  For instance, about 44% of Alexian Brothers patients are covered by Medicare.[27]  While the reimbursement rates for Medicare are higher the amount of patients on the program are growing.[28]  As a result of the growing aging population, Medicare may become a greater financial burden on hospitals in the future.[29] 

B.  Type of patient: uninsured and older 

 

The number of uninsured individuals is increasing causing many hospital services to go unpaid.  For instance, the number of uninsured has increased from 44.8 million in 2005 to 47 million in 2006.[30]  As the amount of uninsured increase more are going to hospital emergency rooms for their basic health care needs not emergency services.[31]  This is increasing the amount of debt hospitals are facing because state and federal law often require hospitals to provide care for people going to the emergency room regardless of their ability to pay.[32]  The Emergency Medical Treatment and Active Labor Act (“EMTALA”), a federal statute enacted in 1986, requires hospitals with an emergency room department and that participate in Medicare to take uninsured individuals and provide them with emergency treatment.[33]  Under EMTALA hospitals must screen an individual who requests care and if that person is found to have an emergency medical condition the hospital must stabilize that individual before transferring him to another facility.[34]  Critics of EMTALA allege that uninsured individuals are using the emergency room department more frequently for non-urgent care.[35]  Since the enactment of EMTALA in 1986, visits to the emergency room have increased from “85 million visits per year to almost 110 million visits per year, while more than 550 hospitals and 1,100 emergency departments closed, as did many trauma centers, maternity wards, and tertiary referral centers.”[36]  This suggests that EMTALA is a significant drain on the hospitals resources and capital. 

In addition to a higher number of uninsured, people are living longer and therefore requiring more care and longer hospital stays.[37] It is estimated that by 2030 the population of people that are 65 and older will increase from 27 million in 2006 to 71.5 million.[38]  Also, between 1992 and 2004 the average estimated health care costs of older Americans increased from $8,644 to $13,052.[39]  As a result, hospitals will be treating sicker and older patients who will be staying longer in hospitals.[40] 

 

C.   High cost of hospital resources: updated equipment, training and labor
  

Technological advances in the field of medicine can cause a hospital to become outdated if it does not keep up with the changing technology.[41]  Keeping up to date with current technology can cause a hospital to incur significant costs for purchasing the equipment and training the staff to use the equipment.[42]  However, if the hospital does not keep with the technological changes it may lose patients because they will be more likely to go to a hospital that has state of the art equipment.[43]  In addition, technological advances in the field of medicine have reduced the need for medical care and the length of inpatient hospital stays.[44]  As a result hospitals will be losing revenue because patients no longer need extensive and long medical treatment.[45]

             

Also, there are increased labor costs due to an acute shortage of registered nurses.  According to a report released by the American Hospital Association in 2007, U.S. hospitals need approximately 116,000 nurses to fill vacant positions nationwide, meaning that a national registered nurse vacancy rate of 8.1 percent.[46]  Furthermore, the demand for registered nurses is expected to grow by 2 percent to 3 percent each year.[47] 

IV. Recommendations for hospitals in financial distress 

What can be done to prevent hospitals from closing their doors?  Hospitals around the country are approaching their financial distress with various cost saving approaches.  The approaches outlined below are only a few of the many considerations that a hospital can make when determining how to stay financially viable during the economic crisis.   

A.  Uninsured patients

One of the largest financial burdens that hospitals face is uncompensated care that is provided to uninsured individuals, especially in the emergency room department.  Hospitals around the country have started charging uninsured patients for non-emergency treatment.[48]  For instancee, in Atlanta the Grady Health System began charging fees for non-emergency visits based on a sliding scale to residents that live outside of Fulton and DeKalb counties.[49]  In Cleveland, the MetroHealth Medical Center “implemented a $150 charge for uninsured patients living outside of the county.”[50]  This was designed to make an effort to divert patients from the emergency room to its primary-care physician offices.[51]   Charging fees for non-emergency room services may divert patients from using the emergency room department but the uninsured patients are still not going to be able to pay their bills.  Research shows that uncompensated care costs the hospital industry up to 41 billion annually.[52]  This includes both uninsured and underinsured patients who are unable to pay their hospital bills.[53]  Marty Callahan, vice president for Health Care Solutions for Transunion, recommends that when hospitals are dealing with underinsured or uninsured patients they should focus on identifying the patient and matching them with charity care or other financial assistance programs or setting equitable payments plans.[54]  By verifying patient information thoroughly hospitals are able to lower the amount of uncollectable debts from patients that cannot be located.[55]  Also, providing patients with financial assistance and manageable payment plans will increase their likelihood of payment.[56]  

B.  Monitoring productivity and resource consumption

 

One of the largest expenses for hospitals is labor and supplies.[57]  Therefore, one of the best ways for a hospital to save money is to monitor and control expenses on labor and supplies.

 

Alexian Brothers Medical Center has a healthy operating margin of 3.8 percent and serves as a good example of what can be done to save costs.  In order to control labor costs Alexian Brothers monitors the productivity of each department daily.[58]  First, the hospital considers what the patient will need to ensure that patients are receiving the highest quality care.[59]  Second, the hospital looks at the productivity of each department and compares it with the expectations or bench marks set in each department.  Productivity measures are specific to each department.[60]  For instance, for central transportation productivity is measured by productive hours per patient transports, surgery is measured by productive hours per surgical minute, and laboratory is measured by productive hours per test performed.[61]  This allows the hospital to determine daily how each department should be staffed and ensures that the hospital is making the most cost effective decisions.[62] 

  

Supplies are also significant expenses for many hospitals and therefore effective resource utilization is an important part of saving costs.  Alexian Brothers puts teams together that focus on monitoring resource consumption and look for ways to save money but still retain a high quality of care.[63]  The hospital focuses on making sure that the patient is receiving the appropriate level of care for the appropriate amount of time[64].  First, the patient needs to be timely screened and the results need to be obtained quickly.[65]  Second, the patient needs to be treated timely.[66]  This ensures that the hospital is decreasing bottlenecks, or the time between the physician ordering the test and it being performed and the results received.[67]  Also, the hospitals monitors whether physicians are conducting the appropriate amount of tests and that they are not over testing.[68]  By eliminating delays and unnecessary tests the hospital can provide better and quicker care to the patient and save time and costs.[69]  In addition to monitoring resource consumption, Alexian Brothers looks to make sure that the hospital is not overpaying for supplies by standardizing with a particular vendor.[70]

 

C.     Better financial oversight  and management

Requiring hospitals to have better financial oversight and management can also help hospitals regulate their finances and prevent bankruptcy.  Many times the executives find themselves concerned for preserving their jobs rather than focusing on the financial well-being of the hospital.[71]  In states, like New Jersey, the legislature has decided to take action in order to monitor hospital finances and make sure that hospitals are not closing down.  For instance, the New Jersey legislature passed a law which requires hospitals to file financial statements monthly rather than quarterly.[72]  The law “also allows state officials to impose monitors at struggling hospitals and in extreme cases state officials could veto power over a hospital's actions.”[73]  Other measures designed to increase transparency “require hospitals to hold annual public hearings to give communities a glance at their inner workings.”[74]  Also, the law requires “mandated training and financial oversight for hospital boards of trustees.”[75]  In addition, a $44 million "hospital stabilization" fund was created, which will be used to prop up struggling safety-net hospitals.”[76] 

 

Improving management and increasing transparency in a hospital is one of the primary ways to ensure that hospital finances are being utilized in an effective way to prevent low or negative operating margins.[77]  First, monitoring the behavior of financial managers and holding them accountable for their mistakes is a good way to ensure that hospital resources and capital are being utilized properly.[78]  Second, setting goals for the organization in terms of how much money is spent in each department as well as for overhead costs.[79]  Finally, it is important for a CFO to implement flexible budgeting techniques that can be changed with the current market fluctuations.[80] 

D.   Increasing or changing the quality of services provided 

Hospitals can also change or increase the quality of services they offer in order to be able to compete in the market.  For instance, a hospital can invest money to develop their cardiac or cancer treatment centers which will attract more patients from different areas.[81]  It can also attract more fee-for-service of PPO patients which can help the hospital make a higher profit in the long run.[82]  New programs and treatment centers will also influence more doctors and nurses to join their hospitals.[83]  This may cost money to develop but it has the potential to bring in higher profits because specialized care cost more money and attracts more patients who are unable to receive this care in other hospitals or from their physicians.

E.    Cutting staff, benefits, and services  

Reducing benefits is also another way to save costs.  For instance, the Goshen Health System deferred merit increases, reduced paid vacation time and suspended its retirement matching program in order to save costs.[84]                 

 

Hospitals all round the country are finding ways to save money and sometimes this involves cutting services or staff.  A recent American Hospital Association survey has reported that many hospitals around the nation are forced to cut staff as a result of financial difficulties.[85]  Furthermore, hospitals are also cutting services, such as behavioral health programs, post-acute care, clinics and patient education to save money.[86]  Unfortunately, these solutions can affect the quality of care that people are receiving in hospitals.  Therefore, hospitals should try to balance quality of care concerns with financial management in order to ensure that patients are receiving the best care possible.

 

F.     Consolidations and acquisitions  

Another way for weaker hospitals to improve efficiency and save costs is by merging with stronger facilities.[87]  Mergers occur when separate hospitals come together under a shared license and “have common ownership, do business under a single license, report unified financial records, and possibly consolidate some physical facilities.”[88]  On the other hand acquisitions are “when joining hospitals retain their licenses but are owned by a common governing body.”[89] 

Mergers provide a good solution for weaker hospitals who are considering closing down.  Mergers can provide hospitals with cost savings, greater access to capital, improved utilization of resources, and more efficiency in the delivery of health care.[90]  By saving costs the hospital decreases its operating expenses and as a result consumers can enjoy lower health care costs.[91] 

However, there are also many disadvantages to mergers.  Critics allege that mergers have been responsible for price increases in services and lower quality care.[92]  Mergers can result in large multi-hospital systems which obtain considerable market power in local communities.[93]  As a result multi-hospital systems decrease the amount of competition which can result in increased prices.[94]  Mergers can also cause complications with the hospital management and organizational structure which can lead to hospitals closing down or becoming less efficient.[95]  Mergers are a possible solution for hospitals facing financial difficulties but given the disadvantages hospitals should consider other alternatives before heading in that direction.   

V.     Conclusion

 

If hospitals are unable to keep open and provide services this can have a devastating affect on access and quality of health care in the United States.  Studies have indicated that hospital closures in rural parts of the country are having devastating effect on the health of the citizens.[96]  Several studies have indicated that hospital closures in rural areas have caused “perception of a loss of quality of life and health status, an increase in the waiting time for routine medical care, and a decrease in medication compliance.”[97]  In addition, residents reported that they have problems in securing transportation to travel to other facilities and that their travel time has increased.[98]  These barriers become even more problematic for vulnerable populations such as pregnant women, children, and elderly.[99]  In addition, low income individuals are suffering even greater barriers to accessing health care since hospitals often times are the only providers in the area that take Medicaid.[100] What can be done to fix the financial problems of hospitals and provide American’s with access to health care?

 

The solutions discussed above are a good place to start for hospitals facing financial difficulties.  However, the solutions are limited in scope and can only fix some problems.  Inevitably some hospitals will have to close their doors.  This is a concern that should be addressed at a higher level than the hospital managing boards.  Its time for legislatures to start taking actions and subsidizing the costs of hospitals.  The current health reform will change the financial conditions of many hospitals but the future is still uncertain.  The current health care bills indicate stronger support for government programs such as Medicaid and Medicare and increasing access of health care to more individuals.  This may hurt hospitals that are already experiencing financial problems as a result of low reimbursement.  However, if reimbursement levels are improved this may provide hospitals with the necessary capital to continue their operations.  Unfortunately, this is beyond the scope of this paper and should be considered in greater detail as the health care reform bills pass and their plans are put into action.   


[1] Samuel R. Maizel, Shane Passarelli, and George D. Pillari, The Financial Crisis Facing America’s Hospital Industry: Part I, 27-JAN Am. Bankr. Inst. J. 16, 55, 56 (2009). 
[2] Id.
[3] Id.
[4] A Community Leaders Guide to Hospital Finance, http://www.accessproject.org/downloads/Hospital_Finance.pdf (last visited March 7, 2009). 
[5] Id. at 16.
[6] Id. 
[7] Robert S. McWhorter, The Industries Most at Risk in Bankruptcy: Legal and Financial Experts on What to Expect, Avoiding Financial Trouble, and Thoughts on the Future, 2008 WL 5689292, 109 (2008). 
[8] Id.
[9] Id. at 25.
[10] Id. 
[11] Whorter, supra note 7, at 107.
[13] Whorter, supra note 7, at 107.
[14] Id.
[15] Hospital Margins Sink with Economy, AHANews.com, available at http://www.ahanews.com/ahanews_app/jsp/display.jsp?dcrpath=AHANEWS/AHANewsArticle/data/AHA_News_090316_Report_hospital&domain=AHANEWS.
[16] Id. 
[17] Under Payment for Medicare and Medicaid Fact Sheet, American Hospital Association.  http://www.aha.org/aha/content/2009/pdf/09medicunderpayment.pdf. (last visited March 3, 2010).
[18]  Id.
[19] Id.
[20] Whorter, supra note 7, at 110.
[21] Economy forces hospitals to cut staff, services, AHA News, April 27, 2009.
[22] Id.
[23] Interview with Sherri Vincent, Chief Financial Officer of Alexian Brothers Medical Center, in Elk Grove Village, IL. (March 11, 2009).
[24] Id.
[25] Id.
[26] Heidi B. Malhotra, Financial Crisis Looms Over Healthcare Industry, The Epoch Times, May 3, 2008. 
[27] Vincent, supra note 24.
[28] McWhorter, supra note 7, at 110.
[29] Id.
[30] Id. at 109. 
[31] Laura D. Hermer, The Scapegoat: EMTALA and Emergency Department Overcrowding, Journal of Law and Policy, 695 (2006). 
[32] Id.
[33] Id.
[34] Id. at 699-700.
[35] Id. at 703. 
[36] Id. 703-704.
[37] McWhorter, supra note 7, at 110.
[38] Vicky Cahan, Americans Living Longer, Enjoying Greater Health and Prosperity, but Important Disparities Remain, Says Federal Report, National Institute on Aging, available at http://www.nia.nih.gov/NewsAndEvents/PressReleases/PR20080327OlderAmericans.htm.
[39] Id.
[40] Id.
[41] McWhorter, supra note 7, at 109.
[42] Id. 
[43] Id.
[44] Maizel, supra note 1, at 58.
[45] Id.
[46] Id. at 55-56.
[47] Id. 
[48] Diana Manos, Hospitals Find Ways to Cope with Increase in Uninsured Visits, Healthcare Finance News, May 26, 2009.
[49] Id.
[50] Id. 
[51] Id. 
[52] Marty Callahan, What Every Hospital Should Know, Financial Management Whitepaper, available at http://www.futurehealthcareus.com/?mc=uncompensated-care&page=fin-viewmarketplace.
[53] Id.
[54] Id.
[55] Id.
[56] Id.
[57] Lindsey Dunne, 10 Best Practices of Increasing Hospital Profitability, Becker’s Hospital Review, available at http://www.hospitalreviewmagazine.com/news-and-analysis/business-and-financial/10-best-practices-for-increasing-hospital-profitability.html. 
[58] Vincent, supra note 23. 
[59] Id.
[60] Id. 
[61] Id. 
[62] Id. 
[63] Id. 
[64] Id. 
[65] Id.
[66] Id. 
[67] Id. 
[68] Id. 
[69] Id. 
[70] Id. 
[71] Maizel, supra note 1, at 57.
[72] Jonathan Tamari, Doing more to keep Hospitals Alive, Philadelphia Inquirer Trenton Bureau, Aug. 24, 2008.
[73] Id. 
[74] Id.
[75] Id.
[76] Id. 
[77] Steven H. Berger, 10 Ways to Improve Heath Care Cost Management, Heathcare Financial Management, Aug. 2004, 2. 
[78] Id. 
[79] Id.
[80] Id. at 3.
[81] Whorter, supra note 7, at 118.
[82] Id.
[83] Id.
[84] Dunne, supra note 57.
[85] Id. 
[86] Whorter, supra note 7, at 111.
[87] Renee Tomcanin, 4 Trends in Hospital Financing: Discussion With Claudia Gourdon of Healthcare Finance Group, Becker’s Hospital Review Magazine, August 19, 2009, available at  http://www.hospitalreviewmagazine.com/news-and-analysis/business-and-financial/4-trends-in-hospital-financing-discussion-with-claudia-gourdon-of-healthcare-finance-group.html. 
[88] David Dranove and Richard Lindrooth, Hospital Consolidation and Costs: Another Look at the Evidence, Northwestern University, 3, March 1, 2002, available at http://www.kellogg.northwestern.edu/research/chime/papers/Hospital_Consolidation.pdf.
[89] Id. 
[90] Jennifer R. Conners, A Critical Misdiagnosis: How Courts Underestimate The Anticompetitive Implication of Hospital Mergers, 91 California Law Review 543, 548 (March 2003).
[91] Id.
[92] Id.  
[93] Id. at 545.
[94] Id.
[95] Id. 
[96] Susan Reif, Susan DesHarnais, Shulamit Bernard, Effects of Rural Hospital Closure on Access to Care (North Carolina Rural Health Research Program, Working Paper No. 58, 1998) available at http://www.shepscenter.unc.edu/rural/pubs/report/wor58.pdf.
[97] Id.
[98] Id.
[99] Id.
[100] Id.
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