Health systems continue to see expenses outpacing revenues, with high labor costs remaining a stubborn problem. But there are some reasons for optimism.
Hospitals endured a calamitous year financially in 2022, and this year is proving to be problematic.
Kevin Holloran, senior director overseeing nonprofit health care for Fitch Ratings, outlined the headwinds hospitals are facing due to higher expenses, specifically labor costs.
‘We're still having a very difficult year in 2023,” Holloran said.
In a webinar Wednesday, Holloran ran down the formidable difficulties hospitals are likely to endure.
Labor costs and expenses for supplies remain “very, very high in 2023,” Holloran said.
However, he also offered some optimism that health systems are moving toward better days as the year goes on, even if it doesn’t necessarily mean a swift return to profitability. Earlier this year, Fitch suggested there’s some light at the end of the tunnel for hospitals in 2023.
To be sure, hospitals will be navigating some bumpy roads to get through that tunnel.
‘Canary in the coal mine’
Last summer, Fitch determined the outlook for the nonprofit hospital sector was “deteriorating” (formerly described as negative), and the hospital sector continues to have a deteriorating outlook for 2023.
In reality, hospitals have been operating in a negative environment for some time, and Holloran doesn’t see the landscape worsening. But he also said, “There was really no appetite in my mind to say, ‘Oh, it's improving, or it's back to neutral.’”
Hospitals continue to struggle with personnel costs, which are accounting for well over half (56%) of their total operating revenue, Holloran said. He said that figure actually understates the labor costs, since it only covers the salaries, wages and benefits of employees. It doesn’t include temporary or contract labor.
“Iif you had to look at … where's your canary in the coal mine, where's your smoking gun, it really is no surprise,” Holloran said. “It's salary and wages and bennies that are taking away most from your profitability.”
Generally, personnel costs should be no more than half of operating revenue to ensure profitability, Holloran said. When expenses are reaching 55% of operating revenue, it “eats into one’s ability to earn a profit.”
When personnel costs reach 60% of operating revenue, Holloran says, “There’s no way you’re making a profit.”
Hospital revenues have actually been solid, Holloran said. For hospitals rated by Fitch, revenues grew by 6.2% in 2022.
“I've got to tell you, what we're seeing, revenue is not necessarily the problem,” Holloran said.
However, expenses rose by 10.5% in 2022, well above the gains in revenues, he said. Health systems are going to have to find a way to reduce expenses.
“The major culprit here to operations, and even the hits to the balance sheet, has been that expansion of the expense base,” Holloran says. “That's really where the story has been. Fix that, and everything else starts to solve for itself pretty quickly thereafter.”
Hospitals rated by Fitch have less cash on hand. In 2021, hospitals had cash on hand to operate for about 266 days. In 2022, the number fell to about 221 days.
While higher labor costs are the main culprit, investment losses also have eaten into hospital revenues, Holloran notes. Stock markets dropped about 20% in 2022, and hospitals also endured losses in investments, adding to their financial woes. But the higher expenses remain the bigger problem than the investment losses, he says.
Fitch will be compiling final medians for 2022 later in the year, but he says, “2022 is likely setting up to be operationally one of the worst years for our rated universe.”
Keep in mind, hospitals choosing to be rated by Fitch, and other rating agencies, typically tend to be in solid financial shape. And even those institutions are struggling.
Signs of progress
Given all of those financial hardships, hospital leaders are pining for a turnaround.
And Holloran does see some promising developments.
Hospital volumes are rebounding, Holloran says. Hospital expenses for temporary or contract labor have stabilized in recent months.
“Even now the lower rates are higher than what they were pre-2022,” Holloran says of pay rates for contract labor. “But they are markedly better than what they were at the worst points during 2022.”
Health systems are also beginning to see some dividends from efforts in recruiting and retaining workers, Holloran said. The number of people joining hospitals is outpacing the number of those walking out the door, he says.
“More importantly, a lot of those new hires are rehires, or experienced hires that are coming in,” Holloran says.
Some of the returning workers are nurses, which Holloran says is especially valuable because they can hit the ground running.
Hospitals have been working to reduce expenses over the past two years, and those efforts are seeing some success, he says.
Looking ahead, Holloran said he expected some hospitals to be on the path to profitability later this year. He didn’t expect that all hospitals would be turning a profit, per se, but as the year progresses, Holloran said he hoped to see many hospitals getting to the point where they are showing regular improvement.
“It won't necessarily mean that they're break-even or better on operations for the fiscal year, but it means that that trendline is pointing in the right direction, and that month after month is a little bit better than the prior month,” Holloran says.
He acknowledges the possibility that optimism for future gains could be “something like a green mirage,” and unexpected challenges could emerge.
But overall, Holloran expects most of the nonprofit hospitals in the “rated universe” should be showing signs of recovery as the year progresses.
“I think largely speaking, that's still what we think is going to happen in 2023,” Holloran says.