Volumes May Improve, but Medicaid and Medicare Could Pressure Hospitals in 2012

Reprinted from HEALTH PLAN WEEK, the most reliable source of objective business, financial and regulatory news of the health insurance industry.

By Steve Davis, Managing Editor
January 16, 2012 Volume 22 Issue 2

Despite the still sluggish economy and low admission rates, publicly traded hospitals maintained their profitability in 2011. But continued low patient volume, combined with growing enrollment in low-paying government programs, could give hospitals more incentive to pressure insurers for higher reimbursements during contract negotiations.

Michael Waterhouse, an equity analyst at Morningstar, Inc., says patient volume among the hospitals he tracks is improving, but says it isn’t likely to surge this year. And despite improved patient volumes, he predicts hospitals will need to overcome considerable headwinds in 2012.

In mid-2011, commercial insurance enrollment increased, while Medicaid enrollment growth declined considerably but remained positive, he says. “While there appears to be a lag from insurance trends to hospital volumes — since Medicare and Medicaid admissions continue to provide a large portion of admissions growth — these trends should begin to improve the hospital patient mix in 2012,” Waterhouse tells HPW.

Despite an increase in commercially insured members, “there still seems to be a hesitation for actual health care utilization,” likely due to continued economic uncertainty and higher cost-sharing provisions in their health plans, Waterhouse says. But while low patient volume overall is a threat to the bottom line, low “Medicare and Medicaid reimbursements are the biggest incentive for hospitals to pressure the insurers” at the negotiating table, Waterhouse says.

Some hospitals might see a reason to forge new relationships with insurers. According to a December report from consulting firm Booz & Co., health systems “are preparing for a world where access — to doctors and diagnostics, primarily — care management, and cost control will matter more to their overall success and financial health than having a hospital in every part of the market.” And an increased emphasis on improved care management and better cost control will increase the need to “forge new relationships” with health plans.

“New state-of-the-art ambulatory care centers are likely to supplant inpatient facilities as the preferred strategy for market access and penetration,” Booz predicts. The report also suggests that the momentum toward more coordinated and patient-focused accountable care will continue among providers.

Despite continued low patient volumes, low inflation for labor and supply costs combined with cost-control measures will help hospitals and health systems maintain profitability in 2012, according to a report released Jan. 9 by Fitch Ratings.

For investors, publicly traded hospitals could become a more attractive option in 2012 as utilization increases among commercially insured patients. “Hospitals are much more sensitive to a modest rise in commercial utilization” than are health insurers, given that commercial medical loss ratio (MLR) averages are expected to increase between 0.5% and 1.5% in 2012, Cowen & Co. analyst Christine Arnold wrote in a Jan. 6 note to investors.

An increase in the labor force also bodes well for providers. The nation’s unemployment rate stood at 8.5% in December, down from 8.7% a month earlier and 9.4% a year ago. However, long-term unemployment and the number of part-time workers as a percentage of the work force remains elevated, which could help hold down utilization levels, Arnold wrote. Waterhouse agrees and says the long-term unemployed and involuntary part-time workers will likely continue to be a drag on utilization. And as overall utilization improves, hospital acuity levels will decline as previously deferred, less critical patient procedures return to the market.

In her note, Arnold suggests that once unemployment peaks, an increase in medical cost trends typically occurs between three and five years later, typically when unemployment falls to 6% or less. For example, unemployment peaked in 2003, and medical trends rose in 2008. If history were to repeat itself, medical trends would accelerate in late 2012 and continue until 2015. For health insurers, “This is no time to be complacent with respect to medical cost trends,” she warned.

Cost-Containment Efforts Have Impact

In a recent update to its 2011 guidance, hospital chain Hospital Corporation of America (HCA) suggested an improved outlook driven largely by continued volume growth in the fourth quarter, “despite Medicaid rate pressure and lower acuity levels,” Oppenheimer analyst Michael Wiederhorn wrote in a Jan. 10 note to investors. He added that company’s cost-containment initiatives seen in the third quarter have been effective.

To counter pressures, including a rapidly increasing Medicare payer mix, hospital systems will need “long-term” cost reductions of 20% to 25%, according to the Booz report. “As scary as this number may be, leading players will get there and will be rewarded.”

Fitch expects that hospitals will “apply strong cash generation” to acquisitions to help counter flat organic growth. Some hospital systems, according to the ratings firm, have taken advantage of favorable conditions in the bond market and have renegotiated credit agreements “to refinance debt and extend maturities.”

But even with available cash, hospital systems might be reluctant to pursue acquisition targets due to uncertainty surrounding the Supreme Court’s ruling on key provisions of the reform law and the November elections. Entities considering a transaction “will want clarity on government policy and reimbursement protocol, and the hurly-burly of election-year promises will not give them clarity,” says Sandy Steever, editor of the Health Care M&A Monthly published by Irving Levin Associates, Inc. Former Massachusetts Gov. Mitt Romney (R) has said he will repeal the reform law, while Obama would keep it. “The net effect of this on the market is to lengthen due diligence and slow down deal volume,” he tells HPW. A Supreme Court ruling that keeps the reform law intact, however, could spur an uptick in M&A activity “because the potential partners in a deal would have a clearer road map,” he adds. If the court strikes down key provisions, however, such as the development of ACOs, the purchase of physician practices by hospitals would likely slow, says Steever. “But underlying causes for consolidation, such as to capture market share, generate synergies, improve access to capital, improve one’s bond rating, find new efficiencies, etc., all remain in place.”

The full report, For-Profit Hospital Quarterly Diagnosis: Third-Quarter 2011, is available at www.fitchratings.com.