top of page

What if this is as good as it gets?

Updated: Jul 19

What if health system margin pressures don’t relent?


I don’t want to count the number of times I have written about health system margins over the past 20 years. The dot-com recession. Global financial crisis. Overinvestment in commodities. High-deductible doldrums. Disruptive drugs and technologies. Vanishing volumes. A global pandemic. And now, of course, huge spikes in costs. It’s certainly not news that health system margins have been weighed down, with some indexes showing negative operating margins for 12 months. It's true that those pressures have eased somewhat over the past few months, but hardly to sustainable levels.


To adapt Tolstoy: all happy economies are alike, and every economic crisis is unhappy in its own way—and yet somehow, there was always a standard tried-and-true playbook for hospitals and health systems. It goes something like this: cut administrative and supply costs where possible, try to capture profitable market share, consolidate if necessary, embrace automation, conserve capital, reduce headcount selectively and only when all else fails. In other words: go back to basics, muddle through as best you can, and wait for prices to rise and patients to return. Hunker down, because this too shall pass.


But today I am starting to question whether what has worked before will work as well again. Two reasons to question the muddle-through playbook:


(1) The principal cause of health system margin challenges is the enormous upward pressure on labor costs. Labor is still scarce, and the unprecedented changes wrought by the pandemic have permanently altered the contract with all labor in health care, but especially with clinical staff. The job is more difficult, more dangerous, and therefore more expensive. Reducing headcount is nearly impossible in many places. Cost control in healthcare in never easy, but if we’re honest, it’s a lot easier when the pressures are coming from the broader economy. But today the pressure on health systems is coming from within.



Which brings me to my second point.


(2) Even if providers received price increases, they would not be sufficient to offset the labor cost crisis. Historically, unchecked labor cost growth has been harsher on hospital finances than robust pricing growth has been beneficial. And while there is ample evidence that serious price hikes are on their way, the sheer magnitude of the cost increases that many markets have seen means that even a big price hike is going to fall short relative to the cost burden. It might take years of sustained price hikes from employers and other payers to fully account for the labor cost inflation of the past couple of years. That’s a long time to muddle through.

So this has to leave health system leaders with a frightening thought: What if this is as good as it gets? For the foreseeable future at least. How about a speculative thought experiment that pairs real analysis with numerous assumptions about the future? Let’s do it. And for the record, today we’re just focusing on hospitals and health systems.

Nine potential consequences of ongoing provider margin pressure


Capital investment in infrastructure will falter. As credit spreads widen between the relative haves and have-nots, debt will become even more expensive for not-for-profit systems in need of new or replacement construction. Interest rate hikes have raised debt costs across the board, but lower-rated credits will bear the biggest increases, and a sustained period of margin compression will not help. That said, a broader banking contagion may stay the Federal Reserve’s hand for some time (today's rate increase notwithstanding). That will help stave off interest rate increases, but probably won’t help inflation.


Providers will attempt to consolidate, and potentially find themselves thwarted. Financial pressure is usually the most persuasive argument for regulators, but with little evidence that consolidation actually reduces costs (other than capital expenses), health systems have an increased hurdle in getting M&A approved. But they will try.


Expect the return of cross-market M&A. OK, this is an easy one, because we’ve already seen it, with Advocate Aurora merging with Atrium. But it’s an important signal. Pre-pandemic, cross-market mergers had been gaining steam, as large regional systems found themselves with little room to grow locally without incurring regulators’ wrath. But the extreme cash crunch of the early pandemic temporarily halted that. Major cross-market M&A is challenging enough when credit spreads are narrow. But as they widen with interest rate hikes, it becomes far more doable for a large out-of-town system to acquire a smaller one in another region. These are likely to face more scrutiny from FTC and DOJ, but they’ll be attempted.


Outsourcing will start to look a lot more appealing. Not-for-profit health systems are famously reticent to give up control of almost any operation—administrative or clinical. It can be reputationally risky, and damaging to the mission of increasing employment within their communities. But in a sustained period of margin pressure, models of outsourcing (especially those that effectively re-badge existing system employees) could look not only appealing, but also necessary. Revenue cycle will be a prime target. And I would watch the big health plans and their affiliates, as their models promising greater integration will be getting more attention.


Hospitals will try their best to deploy more top-of-license care, but they should expect significant pushback. Models of care delivery that focus staff only on high-value tasks that they are uniquely credentialed and qualified to do have received lots of attention over the past decade. When done correctly, these can improve efficiency, staff engagement, and patient satisfaction. But caveat emptor: Screwing it up can damage the credibility of the whole concept, with staff often accurately lamenting that their days are filled to the brim with only the most difficult parts of their jobs. Top-of-license has to be deployed with staff engagement at the center.


The weakest system performers will either close or receive bailouts, but you can probably predict which orgs will fall into which category. The orgs that financially struggle the most are often in low-income areas, often serving historically marginalized communities. But that doesn’t necessarily make them the most vulnerable to closure. They are often helped by their regional peers because closure would result in capacity crunches as patients are redistributed. Politically speaking, municipal leaders may find it in their interest to prop up struggling providers. A key metric to watch will be regional occupancy rates. Those above 70% mean that hospitals are just one disaster away from being overwhelmed. Anywhere in the low-60s means there is probably excess capacity in the market, dimming the chances of a bailout.


The battle for market share will only heat up. One of the curious legacies of the pandemic is the way in which it helped significantly shift market share in a number of regions, perhaps permanently. Outpatient gained disproportionately over inpatient, for sure. But anecdotally, we also hear that systems that had slightly more permissive masking or max-capacity policies tended to gain over those that placed greater constraints on patients. I’m not going to make a case for the clinical value of that one way or the other, but in many markets, we hear the share shifts were real. Expect the battle to engage profitable specialists to heat up as many orgs seek to return to the status quo ante.


Procedural care and MA will be front and center. Surgeries have been health systems profit centers for 40 years; margin compression just makes efforts for market share that much more crucial. Those orgs that can expend cash to get that market share certainly will. But Medicare Advantage has also emerged as a major profit center for both plans and providers. For health systems, the sheer amount of utilization driven by MA means it is often the most profitable patient segment on an annualized basis. We should see increased efforts from systems to keep MA patients within the network—especially as MA reimbursement gets more attention from regulators. And speaking of steerage…


Employers will bear the brunt of price hikes, prompting more steerage-first strategies. It may be true that employers will be unlikely to accede to reimbursement hikes that match recent cost growth. But that doesn’t mean that big jumps aren’t on the way. Given labor shortages, most employers are unlikely to ratchet up the high-deductible cost-shifting hydraulic. So to control costs, more are likely to turn to steerage-first strategies (which could include virtual-first plans). Systems that win preference are likely to be the dominant players for the next decade in their markets.


To sum up—when margin problems come from internal pressures, the solutions require long-term structural solutions.


Don’t mistake me: the margin playbook of the past can’t be thrown out. But given the unrelenting pressure on costs, those tried-and-true strategies just aren’t likely to be sufficient—at least not for everyone. We have entered a decidedly unsettled phase in health system dynamics, not just within markets, but between them. We spend a great deal of our time studying these dynamics and are excited to bring the latest research on each of the issues described above to your executive retreat, board meeting, or town hall. If you’d like more information on any of the above, then send us a quick note to info@unionhealthcareinsight.com. And don’t forget to subscribe below for weekly updates from us!


Comments


Join our mailing list to see future posts

Thanks for submitting!

bottom of page