CBO: Future Hospital Profitability Requires More Productivity

September 14, 2016 - To stabilize hospital profitability at a six-percent average profit margin by 2025, providers must increase hospital productivity to offset Affordable Care Act provisions to decrease federal reimbursement rates and implement value-based penalties, researchers at the Congressional Budget Office (CBO) advised.

The report states that hospitals that can boost productivity at a general economy-wide rate (0.8 percent) would need to increase total revenues or reduce costs by an additional 0.2 percent per year, while hospitals that cannot reduce costs through higher productivity would have to boost revenues and cut costs by 0.5 percent per year.

“Those hospitals may face significant pressure in the future, but the extent of that pressure and their profit margins will depend crucially on their productivity growth,” the report stated. “If they achieve the same productivity growth as the economy as a whole—and if they use those gains in productivity to limit the growth of their costs and do not respond to financial pressures in other ways—then the share of those hospitals with negative margins would rise to 41 percent in 2025.”

“But if those hospitals do not improve their productivity at all, or do not use any of their productivity gains to limit their costs, then that share would rise to 60 percent in 2025,” added the report.

Increasing hospital productivity may prove to be a major task for most providers, the report noted. A study cited in the report found that the average annual productivity growth was between 0.3 and 0.6 percent between 1996 and 2005, whereas the economy grew at 1.5 percent in the same timeframe.

CBO researchers analyzed how several Affordable Care Act provisions, including annual Medicare reimbursement reductions, insurance coverage expansion, uncompensated care payment cuts, and value-based incentive payments and penalties, would affect hospital profitability for 3,000 hospitals over the next decade.

Annual Medicare reimbursement rate reductions cause margins to decline

Under the Affordable Care Act, CMS must reduce annual Medicare reimbursement rates for hospitals by recalculating payments to deduct any changes in input prices, such as supply chain costs and average costs per patient, and the estimated average growth in productivity across the economy. CBO researchers found that the annual payment updates will decrease reimbursement rates by an average of 0.8 percentage points between 2012 and 2025.

CMS is also mandated to apply specific annual reductions to hospital payments between 2010 and 2019, which vary by year. The additional reductions would cut reimbursements by 0.4 percentage points.

Compared to pre-Affordable Care Act reimbursement reductions, the proportion of hospitals with negative margins in 2025 would increase from 20 to 25 percentage points and the aggregate margin would decrease by nearly four percentage points.

Insurance coverage expansion increases healthcare revenue

Hospitals are expected to see a boost in total revenue as a result of more insured patients under the Affordable Care Act. Researchers projected that 47 percent of the population that would have been uninsured in 2026 would gain coverage. As a result, researchers reported that hospitals would receive payments for 47 percent of the costs that would have uncompensated.

“Incorporating the effects of the coverage expansions only partially offsets the negative effects on hospitals’ finances of the reductions in Medicare’s payment updates,” researchers wrote.

In addition to Medicare reimbursement cuts, coverage expansions would cause the share of hospitals with negative margins in 2025 to fall by 10 percentage points, causing the two policies to increase the number of negative margin hospitals by 15 percentage points compared to pre-Affordable Care Act levels.

Both policies would also reduce aggregate hospital margins in 2025 by 2 percentage points, the report stated.

To stabilize hospital profitability at a six percent profit margin, hospitals would need to achieve the economy-wide productivity rate.

Incorporating uncompensated care payment cuts and value-based penalty programs

The Affordable Care Act stipulates that CMS reduce uncompensated care reimbursements, such as Disproportionate Share Hospital payments, and develop value-based reimbursement programs that penalize costs for substandard quality of care, such as excessive readmissions and hospital-acquired conditions.

Incorporating the Affordable Care Act’s policies, researchers revealed that the number of hospitals with negative margins in 2025 would increase by six percentage points compared to just annual Medicare reimbursement reductions and insurance coverage levels. The aggregate hospital profit margin would also decrease by one percentage points.

The reductions in hospital profitability would primarily be caused by uncompensated care payment cuts and value-based penalties would have little effected on margins, researchers noted.

However, hospitals would need to boost their productivity levels beyond the economy-wide rate to achieve a six percent profit margin. The economy rate would reduce aggregate margins to 4.8 percent, even though it was able to stabilize hospital profitability with only two Affordable Care Act policies in effect.

Non-Affordable Care Act payment reductions impact profitability

Aside from the Affordable Care Act, CMS has also implemented other Medicare reimbursement rate reductions, such as lower payment rates for inpatient care in 2012 and 2013 to adjust for coding changes, rate changes under MACRA, and value-based penalties for the Medicare EHR Incentive Program.

By incorporating the effects of other reductions in hospital payments with policies under the Affordable Care Act, researchers found that hospitals with negative margins in 2025 would increase by seven to 10 percentage points and the total profit margin would be reduced by 1.5 percentage points.

Even if hospitals maintained the economy-wide productivity rate, hospital profit margins would drop to 3.3 percent and the proportion of hospitals operating with negative margins would increase to 41 percent from 15 percent prior to the Affordable Care Act.

“Thus, even under the most optimistic assumption about hospitals’ productivity growth, the combined effect of all the factors considered in this analysis would reduce hospitals’ margins considerably—again, ignoring potential responses by hospitals to those financial pressures,” researchers wrote.

“According to our calculations, hospitals would have to achieve greater revenue growth or slower cost growth—or some combination of the two—than we have assumed in this paper if they were to achieve the same aggregate profit margins in 2025 as in 2011,” added researchers.

The CBO report detailed four potential responses from providers that could help them boost productivity levels to maximize hospital profitability. The first response would be to reduce healthcare costs, such as decreasing the volume or intensity of services provided during admission, reducing the number of days patients stay in the hospital, employing fewer employees or using a less expensive personnel mix, decreasing amenities, and eliminating capital improvements.

Researchers also explained that hospitals may try to increase revenue through cost-shifting or charging private payers higher prices compared to Medicare and Medicaid, boosting patient volume, upcoding, and reducing the share of Medicare and Medicaid patients. However, the strategies for maximizing revenue may decrease care quality, the researchers pointed out.

Another possible response from hospitals includes addressing both healthcare costs and revenue by implementing alternative payment models, such as accountable care organizations and bundled payment models.

“An important feature of such models is that they give hospitals an incentive to coordinate with other providers or take other steps to reduce the total cost of care while enabling hospitals to share in the savings,” the report stated. “Thus, if the new models work as intended, hospitals’ costs could fall by more than their revenues, partially offsetting the effects of the reductions in payment updates.”

Hospitals may also choose to merge or close as a result of financial pressures, researchers added. Hospital mergers could help providers gain access to more resources and boost their negotiating power with private payers. However, some hospitals could elect to close as a result of decreased profitability.

While CBO researchers could not explicitly identify how hospitals will react to continuous reimbursement cuts and declining profit margins, they did explain that hospital profitability largely depends on the rate of productivity, especially with upcoming payment reform regulations.

“A better understanding of the degree of financial pressure facing hospitals and the potential implications for their financial health and patient care will be important both for policymakers considering changes to the Medicare program and for analysts evaluating those changes,” the report stated.

Dig Deeper:

• Preparing the Healthcare Revenue Cycle For Value-Based Care

• 5 Ways to Increase Hospital Profitability, Aid Revenue Cycle