Nonprofit hospitals hit hard by cost inflation, need 'transformational change,' finds Fitch

Photo: Sam Edwards/Getty Images

The COVID-19 pandemic has been hard on nonprofit hospitals, and without action to address upward pressure on their expenses, the hardships are likely to continue, according to a market update from Fitch Ratings.

Expenses are eroding margins, and it's happening quickly due to the ongoing inflationary pressures of elevated labor, supply and capital costs. Some providers are reporting margins this year that are significantly lower than in 2019, and recovery could take years, Fitch found.

Most have strong balance sheets, which will help offset the lower margins for a time. But that cushion could evaporate without substantial changes to the business model, or if another coronavirus surge hits during the fall or winter.

Business models will have to go through "transformational changes" to survive long term, and in the short term, hospitals will have to manage cost pressures through a combination of rate hikes and relentless, ongoing cost-cutting and productivity improvements.

WHAT'S THE IMPACT?

The last time the country experienced this level of cost inflation was during the late 1970s and early 1980s when inflation reached the low teens. At that time, hospital reimbursement was cost-based and cost increases were passed to government and private insurers under a much more elastic revenue model. 

The Medicare Prospective Payment System, a new payer model implemented in 1983 in response to higher costs, was the beginning of Medicare reimbursement based on a predetermined, fixed amount according to diagnosis grouping.

With ongoing margin pressures, providers may attempt to secure higher rate increases from their commercial payers, according to Fitch. This won't be easy: Commercial payers are also facing similar inflationary pressures and have consolidated in recent years, resulting in increased leverage over health systems. 

Fitch does not expect to see Medicare or Medicaid rate adjustments offsetting inflation, given federal budget deficits, and commercial rate increases are also likely to be well below inflation in the short term.

Still, providers may be able to pursue rate increases that are above what the norm has been in recent years, considering the interdependent relationship they have with payers. Recently, both the University of Vermont Health Network and Rutland Regional Medical Center asked their state's healthcare cost regulator for a nearly 20% rate increase.

Inflation may push more providers to consider mergers and acquisitions, as hospitals seek to generate economies of scale and gain skills to enable them to take on additional risk contracts, according to Fitch.

But regulators are pushing back on mergers more strenuously, in large part over concerns that consolidation will lead to higher prices, potentially restricting a possible solution to address inflationary pressures.

THE LARGER TREND

Inflation is one of the major factors likely to impact premiums this year, according to a recent report from the American Academy of Actuaries. It may have some effect on provider costs, but provider payments typically lag behind the rate of inflation, meaning the real effects may not be felt until later plan years. Still, workforce shortages could put upward pressure on provider payment rates.

Inflation has increased to levels not seen since 1982, the report found. Small-business owners are finding it necessary to increase employees' wages and the prices they charge for their goods and services. It remains to be seen whether employers will stop offering coverage, reduce levels of coverage or decrease employer contributions to mitigate increases in their other business expenses. Any changes could vary by industry.

The actuaries said inflation's impact is likely to also extend to individual and small-group premiums, and will affect providers' supply chains – which may affect negotiations over rate agreements with health plans.
 

Twitter: @JELagasse
Email the writer: jeff.lagasse@himssmedia.com