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According to our new arrival, life is more than mere survival

And if you got that reference in the title, please make sure you're up to date with your colonoscopy screening, because you're the right age. We just might live the good life yet.

Board Briefing Health Systems Slides of the Week
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This Thursday, Union's Board Briefing will examine the state of health systems. Those who know us well know that health systems were our primary focus for the first years of our respective careers, so it's a topic near and dear to our hearts. And the most striking and obvious development in this space right now is the rapid improvement in aggregate hospital and health system fortunes over the past few months.


Ever since early 2020, the provider industry has seemingly been operating in crisis mode of one form or another. Pandemic, violence, staff shortages, labor strikes, wage hikes—until recently, most systems were dealing with one calamity after another. In 2022 and much of 2023, the story was similar nearly everywhere: three years of double-digit labor expense increases had eroded margins to dangerously unsustainable levels. And as we said at the time, the key strategy: hunker down and wait for rising prices to work their magic. Our concern, also voiced at the time, was that pricing alone seemed an unlikely savior; no payer would be able to tolerate premium spikes that matched the jumps seen in labor costs (note how I'm running out of synonyms for "increase" here). So what happened—and what does that mean for health system strategy going forward?

The intensity and suddenness of the recovery are striking. After a year of sluggish improvement, only by December 2023 did hospitals and health systems return to what would traditionally be considered a "sustainable" operating margin. (Quick refresher: not-for-profit systems produce both an operating margin from patient-care and related activities, and an excess margin that includes operations plus investment and philanthropic income. In general, an operating margin north of 2% is sustainable, assuming a total excess margin of roughly double that.)


Which is why the Q1 numbers this year are rather extraordinary. After nearly four years of struggle, hospital finances have roared back to life. And of course that recovery coincides with a challenging Q4 2023 for companies with health plans highly exposed to Medicare Advantage. The recovery can be explained by three forces: pricing, utilization, and acuity. The magnitude of margin improvement was made possible by a favorable (for health systems) confluence of all three vectors. So let's quickly look at each.

Pricing. In March of last year, I fretted that inevitable pricing increases were unlikely to be the salve for hospital margins—at least not to the extent they have been in the past. For the better part of 30 years, pass-through pricing was the go-to strategy for NFP health system leaders. It was especially helpful in managing the increases in uncompensated care seen through much of the 2000s. But with total expenses up 22% over 2019 levels, there was zero chance that provider pricing growth would be up to the task. And indeed, health plan premium growth (a decent if imperfect proxy for pricing) has grown faster than inflation, but not by much, roughly 22%. That sounds like it matches expenses, but remember that premiums only account for employer-sponsored insurance; public payer pricing has grown in low single digits.


Utilization. This one has been well-reported. Volumes are back, y'all. Adjusted discharges are up, at least in aggregate. Backlogs have largely been worked through, so the utilization has been coming from two main factors: (1) new therapies (such as the RSV vaccine) that have increased primary care demand and pushed downstream utilization higher, and (2) higher acuity, resulting in greater-than-expected inpatient demand. The net result has been inpatient volumes increasing by double-digits from the prior year in January and February of 2024. In fact, inpatient admissions growth actually surpassed outpatient, observation, and ED growth in most markets in March.


Acuity. Inpatient care has been on a long-term downward slope for the better part of two decades, as more and more care moves to the outpatient setting. But it's hard to deny that hospitals are seeing sicker patients nearly everywhere. Most of the publicly traded for-profit hospitals cited acuity as a major driver of earnings growth in Q1, with revenue-per-case growing anywhere from 3.5% to 6.8% year over year in the earnings calls we reviewed. And when we see final performance medians on the NFPs, we're likely to see adjusted CMI up across the board. These changes are fueled by a number of factors, from the emergence of more-intensive therapies to general population aging. But the factor that commands most attention is the impact of delayed screenings in the two years starting in March 2020. As most oncologists expected, patients are increasingly presenting with later-stage cancers, with more expensive treatments required.


Expense growth has moderated, but not by much. I didn't cite cost moderation as a major driver of margin performance, because it's more accurate to say that expense growth is no longer eating in to margins. Costs haven't declined by much if at all. But the trifecta of spikes in pricing, utilization, and acuity were able to overcome the new, much higher cost ceiling that providers face.


From survival to strategy


So where does that leave health system executives today? Flush with cash and ready to spend? Well, sort of. For most mid-size and larger systems, the days of struggling to tread water are blessedly past (for now). Cash levels have bounced back, and the favorable trifecta looks set to continue for the time being. But remember that NFPs (80%+ of the health system market) finance capital expenses with tax-exempt debt, and borrowing costs remain high, with market-wide inflation staying stubbornly above the Fed's target. But for the first time in roughly four years, health system leaders have the bandwidth and the cash to focus on strategy. Anecdotally, that's where our conversations with health system execs have been for the past few months.


What's on the strategy menu? Tune in to our Board Briefing on Thursday, May 16, at 1pm ET to learn more, but based on our interviews with health system executives, six topics dominate:


  • Strategic M&A. Most of the acquisitions we saw in the pandemic era were fire sales or shotgun marriages. Execs increasingly are choosy, and are looking more intently at cross-market and cross-industry acquisitions.

  • Vertical partnerships. Related to the above, health systems are looking to partner more aggressively around supporting primary care and home-based care options, and investing in more long-term innovation.

  • Organizational structure and vision. A perennial issue of "what do we want to be when we grow up"--in which leaders look at the optimal governance structure for their by-and-large opportunistically acquired assets: leaders now have the capacity to make bigger decisions.

  • Cybersecurity. Data leaks and ransomware have become regular headaches for leaders, but the Change Healthcare debacle has focused leadership minds on ensuring they have a coherent set of policies and communications when attacks happen.

  • Workforce planning. The long-term challenges here haven't gotten much better, so technology investments to support nurses and physicians are all on the investment menu.

  • Artificial intelligence. Because obviously.


Join us this week!

If you haven't registered for this week's webinar—where we go through all these issues and more, you can do so here—or learn more about getting access to all of our behind-the-paywall content in our ever-expanding research library.



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