2008: The year of financial collapse
In 2008, many industries were dealt a strong financial blow, and hospitals were not immune, although they were not as affected as other industries. According to Mr. Winter, the immediate consequence of hospitals’ financial problems was finding themselves falling into bond covenant violations.
“Hospitals found themselves in violation of the terms of their borrowing agreements,” he says. “This was often tied to the declines in the bond and stock market.”
However, Mr. Winter sees that many hospitals were on the verge of financial decline well before the stock market dropped. According to an Alvarez & Marsal study using 2005/2006 data, more than half of the 4,500 hospitals surveyed in the United States were insolvent or at risk of insolvency at the end of 2006.
“This means that before the crisis, the marketplace was already stressed,” says Mr. Winter.
He also notes that the hospital industry then and now sees a growing rift between hospitals that are extremely successful and those that are financially strapped.
“It’s like the ‘haves and have-nots,'” he says. “Some, like the Mayo Clinic, are doing well and investing in new services and technologies. Others are facing more challenges. I’ve seen many that are generating less than a 4 percent EBIDTA margin, which is the minimum needed to replace capital. Lack of access to capital, at any price, is a significant problem currently facing the ‘have-nots.’ Many of these hospitals have significantly cut back on capital spending, thereby putting them in an increasingly disadvantageous position.”
Hospitals were weak and facing poor reimbursements prior to the economic crisis, according to Mr. Winter. “Some groups were doing better than others, but many were at risk of failure,” he says.
2009: The year of bond covenant violations
In 2009, many hospitals are able to continue to make payments on their debts but have still found themselves in default of their agreements, according to Mr. Winter. He says two factors contribute to this: debt to capitalization and days cash on hand.
This, however, is not necessarily a reflection of how hospitals are running their businesses. “Operations may be better, but their balance sheets have deteriorated,” Mr. Winter says. For example, he notes that the value of securities that lenders show as cash decreased, which also decreased capitalization and cash on hand.
Between early 2009 and May 2009, bond ratings for hospitals decreased. “For every one issue upgraded, Moody’s was downgrading three issues,” Mr. Winter says. As a result, hospitals have had a more difficult time borrowing money.
Additionally, many hospitals were concerned at the beginning of 2009 that they would see an increase of uninsured patients in their emergency departments. Mr. Winter says that this is more of a fear than a reality and has not yet manifested itself as a universal trend, although in some regions this is occurring.
Now: Finding opportunities to improve performance
Opportunity in mergers and affiliations. As a result of the economic downturn, more and more hospitals are driven towards consolidation, says Mr. Winter. Mergers and affiliations are coming out of this trend, and Mr. Winter sees these as opportunities for hospitals.
“These can be very beneficial to hospitals with excessive overhead,” Mr. Winter says. “Rather than worry about recovering those costs, hospitals can focus on patient care. It’s all about the execution of these deals.”
Historically, Mr. Winter says that many not-for-profit mergers meant that a company or hospital system would “collect” hospitals without integration. Billing, information technology and clinical operations were kept separate. “They were challenged from the beginning,” he says.
However, the mergers that are currently occurring seem to be more focused on integration. “Hospital CEOs should make sure that they are using and consolidating the right resources to make mergers successful,” Mr. Winter says.
Another trend in mergers that Mr. Winter has observed is movement towards privatization. “More public hospitals that are cash strapped are trying to control costs by ‘getting out of the healthcare business,'” he says. “They are seeking buyers or partners, and more are considering for-profit partners.”
One aspect that adds to this decision is the availability of future state funding. “More states are strapped for cash, and new funding is likely to be difficult to come by in the next few years,” Mr. Winter says. For many public hospitals, considering a private buyer or partners can help ease these concerns over funding and help them get back to focusing on patient care rather than funding.
Not-for-profit hospitals are starting to follow a similar trend, by considering sale to or partnerships with for-profit hospitals. Mr. Winter notes that this is much different from recent years when for-profit conversions were less attractive to boards than they were 10-15 years ago.
“Over the last seven or eight years, these considerations were only muted conversations,” he says. “Now, they are just conversations, but not-for-profits are being more open about it.”
How many such mergers will actually happen in the next few years remain to be seen, according to Mr. Winter, but far more not-for-profits are considering these arrangements to provide better access to capital. “Capital markets will be the driving force,” he says. “The hospital boards will seek the best options to keep their hospitals viable.”
Whether public or private, not-for-profit or for-profit, merging with a partner who is more financially solvent and contributes greater management depth will be a good step for hospitals, according to Mr. Winter. “These mergers align the hospital with a better performing hospital, and lenders often support struggling hospitals seeking better performing partners to improve on their loans.”
Lenders push hospitals to improve performance. Mr. Winter says many banks and lenders often push hospitals at or near default toward performance enhancement. This may involve focused improvement of revenue cycle or purchasing. Mr. Winter suggests that hospitals should try not to be all things to all people and instead focus on their “core” services. They should also undergo a service line evaluation to determine if they need to abandon any under- or non-performing service lines.
“Hospitals have a natural desire to do a lot of things,” Mr. Winter says. “However, it is necessary for them to shut down services which are not core to their mission and those in which they are not competitive. This can be a hard change for hospitals, but they should concentrate and support the successful services.”
Mr. Winter sees this as a good opportunity for hospitals to improve their productivity and profitability and to see results that will last beyond the short term. By evaluating their procedures and services, hospitals can also focus on improving the operations that are strapped for cash.
“As the economy recovers, hospitals will see their elective surgery business return and will be able to reap the profits with more efficient systems and focused service lines,” Mr. Winter says.
For CEOs and other hospital leaders, Mr. Winter stresses that they should maintain their flexibility and prepare for changes ahead. He suggests the following steps:
- Identify where the hospital loses substantial money in operations and services.
- Know service line profitability and cash flow.
- Identify core vs. non-core services and focus resources on core services.
- Managing expenses to the existing revenue stream.
- Identify opportunities to add new services and/or expand existing profitable service lines.
- Be prepared to take aggressive steps to ensure the financial viability of the hospital.
- Be very effective at managing resources.
- Understand the nuts and bolts of your finances.
- Focus on clinical resource utilization.
Most of all, Mr. Winter says that CEOs need to address any problems in efficiency today in order to preserve their profits and to look more appealing to their lenders.
“Since the economic downfall happened, many borrowers have sought to ‘extend and pretend;’ many hospitals have asked lenders to extend their loans with the hope that everything will be better by 2010-2011”, he says. “However, it is more important to use the time afforded by their loan extension to improve their profitability. This is critical. Lenders today aren’t going to willingly extend loans just because they did so in the past.”
Reaching out to consultants for help at this time is not a sign of weakness, but rather reflects the new uncertain world in which hospitals operate, Mr. Winter says..
Mr. Winter also notes that it is a different world from that of 2006-2007. “Hospital leaders are going to have to aggressively pursue options both inside and outside the box,” he says.
2009 and beyond: Coming out of the Great Recession
Mr. Winter predicts that by 2010, we will be seeing some signs of stability in the economy, and hospitals and other industries will begin to emerge from the recession. Pent-up demand for delayed elective care will also enhance profitability once unemployment rates stabilize, he says. As this stability begins to come around, he notes that hospitals will remain a strong presence in their communities.
“Hospitals are bedrocks,” he says. “They are often a big or the biggest employer in a community, and, therefore, communities depend on them and fight for their success.”
Pension plans will present a challenge. Due to the decline in value of the hospital’s portfolio, pension funding could become a problem moving forward, according to Mr. Winter. He notes a 2009 pension funding study performed by Milliman, which found that in Feb. 2009, overall pension plans were 25 percent underfunded, while they had been fully funded in 2007.
“This requires larger pension payments to reduce the shortfall,” Mr. Winter says. “We have spoken to hospitals facing increases of between 2-7 times last year’s funding payments over the next two years.”
Hospitals need to plan for this problem now, in Mr. Winter’s opinion, as liability growth continues unhindered. “Hospitals need to set aside cash for their pensions,” he says. “In order to do this, they need to focus on operational improvements.”
Mr. Winter says that addressing this problem is a necessity for a successful hospital. “They may not see the effects right now, but it will become painfully obvious in 2010-2011.”
Successful hospitals will be innovators in the face of change. When it comes to hospital profitability, the wild card for hospitals coming out of the recession will be healthcare reform, according to Mr. Winter,
“Healthcare reform will be the foundation for change,” he says. “The changes will be substantial, and this creates the opportunity for management teams to move hospitals forward by seeking out the nuances of those changes.”
One area that will affect the profitability of hospitals is the cost of financing. Mr. Winter notes that this cost and the speed of the recovery will be a challenge. As a result, he suggests that CEOs and hospital management should be flexible and aggressive when it comes to finding opportunities.
“Innovation is required at all levels,” Mr. Winter says. “Change can be a catalyst for good, and it is important to take advantage of what will happen in the next year [with healthcare reform.]”
Mr. Winter notes that in the mid-1990s, when hospital reimbursement formulas were changing, the hospital systems that were the least aggressive at change were most likely to fail.
“There is an ever-increasing demand for capital to fund new technology,” he says. “Hospital management teams will face these challenges and will find way to get funding or change their business models.”
Mr. Winter says these changes will require great ideas, but the execution will be critical. “Innovation, thinking outside the box and aggressive management will set most successful hospitals apart from the rest,” he says. Acquisitions and mergers have grown rapidly over the past few years as hospitals have found that implementation — more than just reports — are the key to success, and implementation is what A&M is often asked to deliver.
“We are in this business to change the way CEOs, COOs and CFOs view the best consulting outcomes,” Mr. Winter says. “Experienced personnel, small teams, high impact, lasting results: I believe this is how executive healthcare will choose consultants to position their hospital for success as the Great Recession comes to a close.”
Mr. Winter is a managing director with Alvarez & Marsal and co-head of the Healthcare Industry Group. Learn more about Alvarez & Marsal.
