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2017 will likely bring fresh financial challenges to health systems: How fast and how far might margins fall?

Financial headwinds are accelerating for our health system clients. Due to a sizeable shift in the payer mix, with lower margin Medicaid and Medicare volumes outpacing higher margin commercial volumes, 2017 will likely to be a tough financial year for many providers. Furthermore, new developments like the Medicare Access and CHIP Reauthorization Act (MACRA) – which has the potential to be transformative in accelerating the shift from volume to value – and the uncertainty of a new administration, paint a tumultuous picture for 2017. To withstand these uncertainties, health system leaders should consider strategies to dramatically reduce fixed costs, gain greater access to the premium dollar through innovative health plan strategies, prepare to move “beyond the hospital” across the continuum of care, and invest in new value-based care capabilities in order to achieve long-term financial sustainability.

What is driving the financial headwinds?

Payer mix – or the percentage of revenue coming from commercial and government payers – is one of the major drivers of financial performance for health systems. Commercial insurance, typically funded by employers and unions, has usually paid more than the cost of services, while Medicare and Medicaid can pay less than the cost of services, on average 40 percent lower than commercial insurance. Additionally, health systems are required to provide care to anyone who comes to an emergency room, regardless of their ability to pay. If patients are unable to pay, this either becomes “charity care,” care provided for free or at reduced costs, or “bad debt,” that typically is not recovered.

The higher reimbursement from commercial payers and consistent growth from Medicare and Medicaid has contributed to a “golden age” for hospitals and health systems. Many hospitals have reported strong operating margins (for nonprofits) or profits for (for-profit systems) for years. However, policy, industry, and market forces could mean changing financial headwinds for health systems in 2017 and beyond.

CMS actuaries estimate that cuts to Medicare’s hospital payment updates implemented under the Affordable Care Act (ACA) would increase the share of hospitals with losses from 27 percent in 2013 to 30 percent in 2019 and as much as 50 percent in 2040.

Over time, revenue from commercial insurance has stagnated as a share of total revenues, while revenues from Medicare and Medicaid have grown. While health systems in states that expanded Medicaid coverage have seen lower bad debt and charity care as a share of revenues, the share of Medicaid revenue has increased. Additionally, in states that have not expanded Medicaid, health systems, and hospitals are not seeing these large shifts in payer mix even with subsidies for individual coverage offered in all states through exchanges.

Meanwhile, private and government initiatives are calling for health systems to upend traditional business models through participating in programs intended to reduce total cost of care, including hospital inpatient and outpatient care. Even as they call for lower spending, these initiatives require new investment into IT, analytics, relationships with clinicians, and exposure to financial risk.

The election adds uncertainty

While it’s unclear what approach the new President and Congress will have with health care, many policies under discussion have the potential to affect hospital finances. In general, any policy that results in fewer people with insurance or more people with greater cost sharing have the potential to increase “bad debt” and “charity care” for hospitals. On the other hand, the new administration and Congress might take action to relieve requirements that hospitals find burdensome; the American Hospital Association and other stakeholders have already shared requests with the new administration.

Smart next steps

So, what are some steps health systems can take, given these challenges?

1. Dramatically reduce costs. In any scenario, health systems should become more cost-efficient to weather the storm. This means fresh approaches to reengineering clinical and nonclinical processes to reduce fixed and variable costs. The historical cost reduction playbook will be necessary, but not sufficient. Health systems will need a new model of delivering care and administering operations to achieve financial sustainability.
2. Define and pursue innovative health plan strategies. As the payer mix continues to evolve and historically profitable volumes move away from the inpatient setting, health systems should adopt strategies that provide greater access to the premium dollar through pre-paid revenue arrangements. For many health systems, this will require health plan strategic collaborations with specific arrangements like Medicare Advantage to start. At the same time, health systems will also need to continue to seek ways to optimize their current fee-for-service revenue cycle to further protect the revenue line.
3. Prepare to transform the clinical care model “beyond the hospital.” As consumers in high-deductible health plans and incentives through MACRA push more services to lower cost sites of care outside of the inpatient setting, health systems will likely need to create clinical care models that span the continuum of care. This will require new partnerships and asset reconfigurations across the continuum of care using new digital and telehealth innovations to enable the successful management of clinical and financial risk for newly attributed populations.
4. Invest in new value-based care capabilities. To deliver on the new value-driven model, fresh investments in data, analytics, talent, care coordination, complex care management, patient engagement, and pharmacy capabilities will likely be necessary. For many health systems, this will likely require tough decisions on how to reallocate scarce investment capital and redeploy resources that are presently focused on initiatives aligned to the volume-driven model.

What will be most challenging for providers is not just successfully executing one of these smart first steps, but doing all four simultaneously. Success will likely require fundamental enterprise transformation.

How fast and how far might margins fall for hospitals and health systems in 2017 and beyond? It’s unclear. But as the system continues down a path toward value-based care, it’s likely that payers will reimburse less and pressure health systems to reduce their costs. We see that 2017 is likely to be a challenging year for our health system clients, with 2018 potentially being even more difficult. These changes to payer mix and financial pressures on all stakeholders who are financing health care in the US are unlikely to change, so health systems will need to develop proactive, winning strategies now in order to survive in the short-term and achieve financial sustainability over the long-term.

 

Author bio

Brian is a principal in Deloitte Consulting LLP’s Chicago office. He is Deloitte’s Value Based Care Integrated Offering leader. He also leads Deloitte’s Go-To-Market Service Offerings for LHSC. He provides M&A, Corporate Strategy, and Financial Management services to Boards of Directors and management teams. He received an A.B. in Psychology from Wabash College, Summa Cum Laude, and an MBA from the Wharton School at the University of Pennsylvania where he majored in Strategic Management, Finance, and Health Care.