Health System Operating Margins Improve, But Still Below 2015 Level

October 29, 2019 - After experiencing an average reduction of more than 38 percent from 2015 to 2017, health system operating margins improved by an average of 13 percent in 2018, according to a recent Navigant analysis.

The analysis of 103 large health systems that own 44 percent of the country’s hospitals showed that operating margins stabilized after facing the sharpest decline in over 40 years. However, margins were still 30 percent below 2015 levels, the consulting firm reported.

“While 2018 was a turnaround year for health systems, achieving sustainable margins over the longer term will require renewed focus on operational efficiency,” John Wiest, an analysis co-author and managing director of Guidehouse, which owns Navigant, stated in a press release. “Doing so necessitates not only better revenue analytics but active management and rebalancing of systems’ revenue portfolios."

The recent improvement in health system operating margins stemmed from better expense control and revenue turnaround, the analysis showed. In 2018, revenue growth exceeded expense growth for the first time in three years, researchers reported, and revenues increased at more than double expenses from 2017 to 2018.

But increases in clinical volume was not behind the revenue turnaround, researchers stressed. In fact, inpatient admissions increased by just one percent in 2018, which was below the rate of population growth, the analysis stated.

Instead, researchers pointed to healthcare merger and acquisition activity.

Fifteen of the health systems analyzed had revenue growth of more than 15 percent while ten experienced revenue growth exceeding 20 percent, the analysis found. Researchers highlighted one system in particular that nearly doubled its revenues by acquiring a large investor-owned nursing home chain.

Other major healthcare mergers and acquisitions, including mergers between UPMC and Pinnacle Health, Advocate Health Care and Aurora Health Care, and Piedmont Healthcare and several Georgia hospitals, also resulted in non-incremental growth in the 2018 fiscal year, researchers reported.

However, smaller health systems performed better from 2015 to 2018 compared to their larger peers with scale, the analysis uncovered.

Health system scale as measured by total patient revenue in 2018 was a negative predictor of operating performance during the four-year period, researchers found. Additionally, smaller health systems experienced greater change in operating profit during the period compared to larger organizations, the analysis stated.

“These findings highlight obvious challenges for systems that have grown through mergers and acquisitions to actually realize the operational synergies they identified in their premerger planning,” Jeff Goldsmith, PhD, analysis lead author and Guidehouse national advisor, explained in the release. “It is taking larger systems longer to achieve claimed synergies from mergers than perhaps their managements realized.”

Healthcare merger and acquisition activity may contribute to both revenue and expense growth depending on the deal. But commercial revenue yield improvement, enhanced revenue cycle management, and EHR optimization also helped health systems improve financial performance from 2017 to 2018, the analysis showed.

In particular, improved revenue cycle management and EHR optimization resulted in health systems prioritizing charge capture, revenue reconciliation, and clinical document improvement, which “has shown to lead to higher quality and increased financial performance, such as reduced insurer claims denials and increased speed of collections,” researchers explained.

Moving forward, health systems should focus on improving operating margins to guarantee future financial success, especially in a value-based and consumer-centric world, researchers stated.

The factors leading to operating margin deterioration from 2015 to 2017 will continue to impact health systems. Those factors include value-based contracts with commercial payers, an increase in publicly funded patients, and increasing claim denial and collection rates from patients with high financial responsibility, researchers explained.

To continue financial performance improvements, researchers advised health systems to:

• Control expenses related to labor, supply, and contracted services (e.g., clinical, support services, health IT, finance)
• Realize a return on investment on physician employment and clinical IT, including leveraging data analytics to identify and fix clinician resource use variation
• Rationalize service lines to decrease programmatic duplication in neighboring hospitals and do away with programs with marginal volumes and/or poor quality
• Surveil and manage revenue portfolios and be willing to make continual corrections in expense trends in the face of revenue problems
• Go after non-traditional providers, especially in the ambulatory space

“Our analysis reinforces our belief that rigorous control over staffing, improved clinical effectiveness, and better resource use are vitally important to the short- and long-term financial health of hospitals and health systems,” Alex Hunter, analysis co-author and Guidehouse managing director, concluded in the release.