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SPECIAL COMMENT
U.S. PUBLIC FINANCE MAY 21, 2014
Table of Contents:
IT SPENDING IS NECESSARY BUT COSTLY 2 HOSPITALS ARE RAMPING UP
INVESTMENT IN OUTPATIENT STRATEGIES 2 THE RISE OF PRICE SENSITIVITY
IS CREATING NEW COMPETITORS 4 MOODYS RELATED RESEARCH 6
Analyst Contacts:
SAN FRANCISCO +1.415.274.1708
Brad Spielman +1.415.274.1719 Vice President - Senior Credit
Officer [email protected]
NEW YORK +1.212.553.1653
Lisa Martin +1.212.553.1423 Senior Vice President
[email protected]
Kendra M. Smith +1.212.553.4807 Managing Director - Public
Finance [email protected]
Building Value: Investments Aimed at New Priorities Create
Opportunities for Not-For-Profit Hospitals
Hospital systems that are focusing investment dollars on
information technology, outpatient services and improved
efficiencies will be best prepared to mitigate the negative impacts
of declining inpatient utilization, shifting payer models and
increased competition from nontraditional participants in the
healthcare industry.
Due to growing consumer price sensitivity and the growth of
consumer choice, the ability for hospital systems to offer value
will be a driver of success. Strategic and appropriate investment
in information technology (IT) and outpatient services should be a
long-term credit positive, but this type of expenditure frequently
has an immediate negative impact on income statements and balance
sheets, depending on the size and success of the investment.
There are three areas of primary consideration:
IT spending is necessary but costly: Achieving value can be
expensive, and there is an immediate consequence to high IT
investment.
Hospitals are ramping up investment in outpatient strategies:
Declining inpatient utilization and the shift to outpatient
services are reducing hospital revenues, spurring hospitals to make
greater investments in ambulatory capabilities and physician
recruitment.
The rise of price sensitivity is creating new competitors:
Driven by heightened consumer price sensitivity, new competitors
are beginning to enter the outpatient arena and defining what value
means.
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U.S. PUBLIC FINANCE
2 MAY 21, 2014
SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW
PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS
IT spending is necessary but costly
Many organizations have hitched their pursuit of value to the
acquisition and implementation of comprehensive and expensive IT
systems. The return on these investments can be allusive, while the
cost can immediately weaken both income statements and balance
sheets.1
Spurred in part by financial incentives built into the
Affordable Care Act (ACA), hospitals have escalated spending on IT
systems with many systems announcing large, big-bang system
conversions. In many instances, these projects represent
significant portions of the organizations capital budget over a
period of several years. For large systems, the total cost can
near, or exceed, a billion dollars.
Depending on project configuration, much of the cost may be
expensed rather than capitalized, reducing operating income. Also
significantly, these projects can increase debt, decrease cash, or
both. Stage I of the Meaningful Use provision of the ACA has
provided approximately $22.5 billion of supplemental funding to
hospitals since 2011, yet in all cases that we have reviewed, the
cost of an acquired IT system has dwarfed the Meaningful Use funds
received.
The short-term credit implications are generally neutral to
negative, depending on the size of the investment and the success
of the initial implementation. Rocky conversions can result in a
spike in accounts receivable, decreased cash flow and lost revenue.
Among rated hospital systems, the impact has varied, with some
systems reporting significant margin degradation during
implementation and other systems experiencing minimal impact.
Longer term, a well-functioning IT system that integrates
electronic medical record management, clinical oversight, billing,
revenue management and customer interfacing may well be a minimum
requirement for organizational success, especially among larger
systems. A comprehensive IT system that has been implemented
successfully and is integrated into the strategy and culture of an
organization can be key to an organizations value proposition, and
be a long term-credit positive.
Hospitals are ramping up investment in outpatient strategies
The shift to observation stays and outpatient services is
resulting in decreased inpatient utilization and lower hospital
revenue.2 Hospital systems that can supplement inpatient revenue
with new, diversified revenue streams are more likely to remain
successful and enhance consumer value. These investments are
generally less expensive than building inpatient capacity and can
help mitigate inpatient utilization declines.
As indicated in our fiscal year (FY) 2013 preliminary medians,
median revenue growth dropped in FY 2013 and remains among the
lowest in recent years. Concurrent with this drop, median expense
growth also dropped but not by as much, leading to median margin
degradation. This is the second year in a row that expenses grew at
a rate higher than revenues (see Exhibit 1).
1 Moodys Investors Service, 2014 Outlook US Not-for-Profit
Hospitals 2 Moodys Investors Service, Profitability and Revenue
Growth Drop in US Not-for-Profit Hospital Preliminary Medians
This publication does not announce a credit rating action. For
research publications that reference Credit Ratings, please see the
ratings tab on the issuer/entity page on www.moodys.com for the
most updated Credit Rating Action information and rating
history.
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U.S. PUBLIC FINANCE
3 MAY 21, 2014
SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW
PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS
EXHIBIT 1
Revenue Growth Remains Low and Continues to Trail Expense
Growth
Source: Moodys Investors Service; 2013 is based on audited
financial statements of 203 organizations; the data prior to 2013
are from different sample sets. However the multiple years of data
accurately reflect the trend in the industry over this period.
A major driver of suppressed revenue growth is the shifting
utilization trends. Per our FY 2013 preliminary medians, median
admissions have been relatively flat over the last two years
(increasing slightly from 23,215 in FY 2011 to 24,027 in FY 2012,
and then dropping slightly to 23,380 in FY 2013) while median
outpatient visits have grown significantly, increasing from 298,927
in FY 2011 to 319,886 in FY 2012, and increasing further to 345,870
in FY 2013 (see Exhibit 2).
EXHIBIT 2
Admissions Remain Stagnant While Outpatient Visits Rise
Source: Moodys Investors Service
Observations stays, which pay less than inpatient admissions,
have also increased significantly in recent years. In FY 2012, the
median growth rate of observation stays was a significant 10.4% and
in FY 2013 it was 8.0% (see Exhibit 3).
3%
4%
5%
6%
7%
8%
9%
10%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Median Annual Revenue Growth Rate Median Annual Expense Growth
Rate
250,000
270,000
290,000
310,000
330,000
350,000
370,000
15,000
17,000
19,000
21,000
23,000
25,000
27,000
29,000
2011 2012 2013
Admissions Outpatient Visits
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U.S. PUBLIC FINANCE
4 MAY 21, 2014
SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW
PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS
EXHIBIT 3
Median Observation Stays Increase Significantly
Source: Moodys Investors Service
Many hospital systems began preparing for this shift several
years ago by investing in outpatient service centers and urgent
care centers. Several communities have seen a marked increase in
the number of urgent care centers, large full-service outpatient
centers and even stand-alone emergency departments. In some cases,
the facilities are large, costing hundreds of millions of dollars
and rivaling the capital cost of inpatient facilities. In most
cases, however, the capital costs are more modest and represent
enhanced value, operating at a lower cost. Hospital systems that
are not successful at adapting business strategies and creating
additional revenue streams run the risk of losing both revenue and
market share.
A challenge with a more outpatient-oriented business strategy is
the need to further align with both primary care physicians and
specialists in order to provide both volume and staffing for
outpatient facilities. Hospitals are engaging in a variety of
strategies to achieve this, including forming joint ventures,
purchasing physician practices and offering independent physicians
incentives (such as participation in an IT system). Acquiring
physician practices is the most direct method to create physician
alignment, but it is also the most expensive.
The rise of price sensitivity is creating new competitors
Growth in high deductible plans and private exchanges is driving
consumer price sensitivity, which is in turn driving growth in less
expensive outpatient services. Nontraditional competitors are
responding, and healthcare services provided by drugstores and
unaffiliated outpatient centers are diverting volumes and revenues
from traditional hospital providers. Hospitals will need to make
additional investments or form partnerships in order to effectively
compete.
Over the last several years, the popularity of high deductible
plans has increased, which has been concurrent with an increase in
bad debt as measured on a median basis (see Exhibit 4). This shift
is a further driver of reduced hospital revenue growth. This trend
is also apparent in the rise of other alternative insurance models,
which hospital systems are attempting to prepare for by upgrading
IT systems. As the dominant healthcare model in the country shifts
from volume to value, income pressures will increase, putting
hospitals income statements at further risk.
4,797
5,736
6,263
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
2011 2012 2013
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U.S. PUBLIC FINANCE
5 MAY 21, 2014
SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW
PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS
EXHIBIT 4
Bad Debt Grows with Popularity of High Deductible Plans
Source: Moodys Investors Service; Kaiser Family Foundation
The increase in consumer price sensitivity and the demand for
increased pricing transparency is a further consequence of the rise
of high deductible plans. Nontraditional participants have
responded to this opportunity by significantly growing retail
medicine. There are currently approximately 1,600 retail-based
walk-in medical clinics across the country3, and it is estimated
that this number will double over the next three years.4 This shift
towards retail medicine is driving volume and revenues away from
hospital systems and other traditional providers. As retail
medicine grows and begins to incorporate other services, it will
become an increasing threat to hospitals income statements.
Retail medicine is changing how consumers view value within
healthcare services. In so far that value means higher quality at
lower cost, consumer focused delivery is helping redefine high
quality as convenient. This shift represents a serious threat to
hospitals because they will have a hard time competing based on
convenience and their overhead for the same services is
significantly higher.
Hospitals will either cede this territory and attempt to make up
the lost revenue elsewhere, or they will need to form partnerships
or find other ways to compete. Some hospitals have begun investing
in self-branded retail services located within malls and other
venues. The returns on these investments so far are mixed, and are
reliant on generating additional patient referrals back to the
hospital. In the final analysis, hospitals will find ways to more
effectively compete, diversify revenues, and offer enhanced
consumer value, or they will likely lose market share and income.
Hospitals that can build true consumer value are more likely to
have long-term success.
3 Convenient Care Association 4 Accenture, Retail Medical
Clinics: From Friend to Foe?
0%
5%
10%
15%
20%
25%
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
2009 2010 2011 2012 2013
Median Bad Debt ($000) People in High Deductible Plans (%)
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U.S. PUBLIC FINANCE
6 MAY 21, 2014
SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW
PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS
Moodys Related Research
Median Report:
Profitability and Revenue Growth Drop in US Not-for-Profit
Hospital Preliminary Medians, April 2014 (167463)
Sector Comments:
US Healthcare Reform: Three Risks Reduce Credit Positives for
Not-for-Profit Hospitals, March 2014 (166602)
Two-Midnight Rule Will Reduce Revenue for Most Hospitals, March
2014 (165866)
Federal Proposal Helps Essential Hospitals But Discourages
Narrow Networks, March 2014 (165635)
Special Comment:
Academic Medical Center Hospitals Maintain Stronger Credit
Characteristics Than Other Not-for-Profit Hospitals, January 2014
(162049)
Industry Outlook:
2014 Outlook US Not-for-Profit Hospitals, November 2013
(160569)
To access any of these reports, click on the entry above. Note
that these references are current as of the date of publication of
this report and that more recent reports may be available. All
research may not be available to all clients.
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U.S. PUBLIC FINANCE
7 MAY 21, 2014
SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW
PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS
Report Number: 170100
Author Brad Spielman
Production Specialist Wendy Kroeker
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