7 Factors to Assess the Sustainability of a Hospital: Assessing a Hospital’s Viability, Its Financial Situation and the Severity of the Threats it Faces

There are approximately 4,500 medical-surgical hospitals in the country. Of these, nearly 2,500 are affiliated with or a part of system, nearly 2,000 are independent, and approximately 200 to 250 are physician-owned hospitals.

Over the last ten years, there have been approximately 70 hospital bankruptcies. This includes approximately 46 from 2000 to 2006 and approximately another 25 to 30 over the last four years.

For a great overview of issues impacting hospital viability, see an article titled "Factors Associated with Hospital Bankruptcies: A Political and Economic Framework" by Amy Yarbrough Landry & Robert J. Landry published in the Journal of Healthcare Management in July/August 2009.  The article stated, for example:

"Bankrupt hospitals are smaller than their competitors.  They are also less likely to belong to a system and more likely to be investor owned. Factors associated with filing organizations are placed into a political and economic framework derived from Park's work on municipal bankruptcy filings. Common nonfinancial factors associate with hospital bankruptcies include mismanagement, increased competition, and reimbursement changes."

The hospitals that tend to go bankrupt are generally independent, smaller and generally not rural. However, there are several hospital systems that have filed for bankruptcy and there are a significant number of rural hospitals that have filed for bankruptcy as well. For example, three-hospital Forum Health, based in Youngstown, Ohio, filed for bankruptcy in March 2009. Community Health Systems has since moved to acquire the system, beating out competitor Ardent Health with a $120 million bid.

A few of the key factors that drive bankruptcy include poor management, some large change in information and/or billing systems, a legal investigation, a large quality problem early on in the hospitals' inception and certain other issues. Smaller hospitals with less cash on hand and smaller operating margins have less flexibility to pursue diversification and can have a much harder time withstanding these kinds of challenges than larger affiliated hospitals.

7 factors
The following provides a brief analysis of seven factors that can drive a hospital towards bankruptcy.

1. Geography. The greater moat and protective barrier a hospital has from other competition, the better chance it has of surviving. The more that a hospital is one of several choices for patients and physicians, the more susceptible it can be to bankruptcy. Hospitals in areas with low levels of competition for both patients and medical staff are less susceptible to bankruptcy than hospitals in more competitive markets. 

2. Physical plant. To remain competitive, hospitals with aging physical plants must weigh the costs of a renovation with the increased business a renovation may bring. Because of the large amount of debt typically taken on by hospital for such renovations, a hospital that does not have to make significant changes in its physical plant or undergo significant physical renovation has a better chance of being able to sustain significant challenges and changes.

3. Physician alignment. Physicians are directly responsible for patient referrals to hospitals, and as such, hospitals with strong physician alignment — through employment, co-management or other relationships — are most likely to maintain or increase patient volume. If a hospital is poorly aligned with its physicians, and the market lacks a great deal of independent physicians to align with, the hospital is much more susceptible to bankruptcy.

4. Payor reimbursement.
There is almost no substitute for being in at least a reasonable reimbursement market. In a very challenging reimbursement market, no matter how strong management is, it can be very hard to thrive. Markets with a single dominant commercial payor can be particularly difficult. With increasing pressures on government-run health program reimbursements, the value of strong private-payor contracts to maintain margins will only increase.

5. Cost structure. Hospitals with a high cost structure either due to high debt, high employee costs or the inability to amortize costs over larger revenues are more susceptible to bankruptcy. High employee costs may include wages and benefits, including pension plans, which have been particularly hard-hit by investment losses brought on by the recent economic decline. Further, hospitals that are unable to make labor and cost changes or undertake changes in the total number of employees are also much more susceptible to bankruptcy.

6. Management. There is very little that is as important as finding a great CEO and leadership of a hospital. If there is one place to over invest in, it is leadership. A leader must be able to block and tackle plus be a business and marketing guru and generate cases and business for the hospital. It is a multi-faceted job that requires great talent.

7. Quality. Quality can cause bankruptcies if either a hospital develops an ongoing reputation for being a low quality provider or if a hospital has substantial quality debacles early on in its history. Early deaths in a facility can be a problem that a hospital can never recover from. Also, a hospitals’ ongoing reputation as a low quality institution can make it very hard to attract patients or physicians.
These seven issues taken together can explain nearly any hospital bankruptcy. Conversely, small independent hospitals that maintain financial success typically experience challenges in only a few or none of these seven areas. For a great paper on this topic, see "The New Community Hospital Imperative" by Kurt Salmon Associates. The Kurt Salmon report states:

"Based on Kurt Salmon’s consulting experience, the following six competitive factors are strongly correlated with the ability of small, independent hospitals to achieve long-term financial success:

  1. Effective geographic barriers
  2. Favorable payor mix
  3. Strong physician alignment
  4. Significant high-quality asset based
  5. Low-cost structure
  6. High-quality care

The most successful hospitals achieve competitive advantage by exploiting at least one, if not more, of these six factors. The most desirable positioning is to compete on factors that are both within the organization's ability to control and that create effective barriers to entry against competitors."

5 financial questions
A separate set of questions that can help assess a hospital's viability relate to its expected investment costs and margins. As mentioned early, hospitals with a reduced need for costly capital projects and other investments are less at risk for bankruptcy. For example, a hospital should assess the following five questions:
  1. Does it have a need for substantial renovation or relocation?
  2. Does it have a need to invest substantially in information technology?
  3. Does it have to examine acquiring practices or make other substantial expenditures?
  4. How do its costs relate to its cash on hand and its margins?
  5. Does the hospital have borrowing capacity?
Severity of threats
  1. In assessing the severity of threats, four situations that a hospital will look at are:
  2. Is it being excluded from payor contracts or is it likely to see significant payor reimbursement declines?
  3. Are the physicians that the hospital relies on (or are the independent physicians in the community) being bought out by competitors?
  4. What is the cost structure as a percentage of revenues?  How does this compare to other facilities?
  5. Does it have a great CEO, CFO in place or not? Can the hospital afford to recruit premier talent?
4 examples of hospital bankruptcy
Hospitals that have filed for bankruptcy in the last few years have struggled due to many of the circumstances described above. A few recent situations include:
  1. Two key physicians on a hospital's medical staff are employed and go to work for a competing hospital. These two physicians made the difference between success and failure for the hospital to break even. Here, the hospital's failure to better integrate those key physicians contributed to its eventual financial failure.
  2. The hospital had too much debt and was built too large. This hospital has approximately $40 to $50 million dollars in debt and about 50 different owners with no specific force for business. In this situation, the hospital took on two much debt and was unable to overcome the debt with its revenue.
  3. Another bankruptcy developed from the implementation of "a custom software concept" and another one developed from the shifting of all billing and collections oversees. In each situation, the hospital lost several months worth of revenues. Here, the hospitals had a cost-structure that could not be sustained with cash on hand or other funds.
  4. A hospital early on had several deaths. This led it not to being able to recover between the mix of malpractice cases and costs, the inability to obtain insurance and the reputational harm to the facility.

The factor and examples listed above provide a brief overview of several issues that can help assess whether a hospital is headed toward severe financial challenges. Hospitals that find them selves at risk should consider what steps can be done to reduce costs and/or increase revenue in order to stave off a bankruptcy. Hospitals that are challenged by a number of these factors may need to consider an affiliation, merger or sale with or to another entity with greater market share, clout and resources if they with to remain viable.

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