The health care landscape in the U.S. has evolved significantly over the past two decades. And although it sometimes feels slow—especially in value-based care and reimbursement--the pace of change is accelerating. Momentum continues to build.
While major legislative and regulatory changes at both the national and state level can drive health care policy quickly and substantively, there are hosts of additional factors contributing to the fundamental changes in the health care delivery system. Hospitals and health systems have had to navigate through increasing levels of competition and disruption; consumerism and the heightened focus on quality measures and outcomes; the rapid growth in technology and big data analytics, the rise of population health and changes in payment delivery models and a fundamental shift in how and where patients are treated. All of these issues and many more are increasingly interwoven into the fabric of today's health care delivery system. To be successful, provider management teams must adapt and adjust or run the risk of being left behind.
S&P Global Ratings believes the not-for-profit health care sector has been incredibly resilient, in large part due to strong management and governance, as over the past 20 years transformation has taken place at an increasing pace, encouraging our belief that even more change is coming. Many of the hospitals and health systems in our rated portfolio have had to manage this evolution, and while credit quality can and will change over time, we believe the majority of our rated portfolio is well-positioned to compete effectively as new strategies are required.
Historically, a review of ratios over time demonstrates that providers have responded well to change as a group, although results have varied among individual organizations. We have written extensively on the key issues that have influenced not-for-profit health care. In particular, "Shifting Competition Leads U.S. Not-For-Profit Health Care Organizations To Accelerate New (And Old) Strategies," published May 14, 2018, on RatingsDirect, which speaks to the broad changes in the sector and how health care organizations are adapting.
As we think about the underlying factors that have influenced providers the past two decades, it is also important to understand how that has translated into operating performance and financial position. While organizational strategies, and how management and governance respond to evolving, and at times adverse business conditions, are equally important to long term viability, so too is how those strategies affect the overall financial profile of a health care organization. S&P Global Ratings analyzes and publishes not-for-profit health care median ratios annually, and has been doing so for over 20 years. We decided to look back at some key financial metrics since the turn of the century and evaluate how hospitals and health systems have fared during a period of transition and constant change.
Median Ratio Trends Over Time
At a high level, broad balance sheet measures indicate improving financial strength and flexibility compared to levels two decades ago, as is also the case for maximum annual debt service coverage. There is clearly more variability in operating and excess margin measures as governmental policies change, myriad operating headwinds persist, and the investment markets wax and wane, but stronger providers have seen margin improvement, while weaker rated providers have been generally stable with some pockets of weakness at the lowest reported rating levels. Furthermore, the long period of operating in a low interest rate environment has certainly benefited most providers, as they have been able to finance strategic capital assets, while keeping carrying costs at very manageable levels.
The ratios highlight a number of interesting trends:
- Across most of the key metrics there is greater definition between rating medians. Where key ratios were once clustered together more tightly, they are now more dispersed, highlighting greater definition between each of the rating levels;
- Net patient service revenue has risen across all ratings for both stand-alone and system providers for a variety of reasons, including addition of many more business lines (among them physician and insurance services) and more recently, increasing industry consolidation;
- Operating and excess margins are more complicated, highlighting the ebb and flow of industry trends since the turn of the century, including increasing joint venture and affiliation activity and investment market volatility;
- Maximum annual debt service coverage has grown in all but the weakest rating levels, highlighting an improving balance between operational performance and debt;
- Growth in days' cash on hand has been a universal success story even as capital expenditures remain robust; and
- Debt levels have been favorable with an improved cushion ratio and declining debt as a percentage of capitalization, both well-established trends.
In general, these ratios highlight a favorable picture of management and governance in not-for-profit health care providers. In our view, senior leadership and management teams have provided guidance and direction through a series of difficult and changing periods and have emerged as generally stronger organizations from a financial profile standpoint. We believe the vast majority of rated hospitals and health systems have the financial discipline and expertise to navigate the challenges over the next decade and beyond, and while there may be some movement in underlying trends in these key metrics, the overall financial outlook, barring any significant shocks from policy or macroeconomic shifts, should remain generally consistent.
Despite not being captured as part of the medians, our view is that industry consolidation has had a favorable impact on enterprise profiles as well. While ample "horizontal" competition exists for both hospitals and health systems, in many markets consolidation has made it more manageable. Nonetheless, competition between hospitals and health systems among themselves and new market entrants seeking to control niche services or some aspect of ambulatory care services, is presenting new and rapidly evolving threats to enterprise profiles.
Key Sector Medians
In the following charts, for systems we have excluded 'BBB' and BBB-' providers as there are too few to provide meaningful analysis. We have also excluded speculative grade for both stand-alone and health systems, as those ratios cover such a wide range of providers ('CC' to 'BB+') that there is high variability and thus the trend is less meaningful.
Health Care Evolution Quickens Its Pace
As we look ahead, there are certainly takeaways from the past that can help inform our outlook, but for us there is always the question: do we let the past be our guide, or is the sector shifting in new ways? In many ways the answer to the latter is yes. The industry continues to evolve, as a raft of new competitors have brought very different approaches to problems. Some trends appear unstoppable, such as the ongoing decline in inpatient use rates despite an aging population. While this and the evolution of care management has ushered in a great many ambulatory care business lines and strategies, the movement of the overall business to one more closely aligned with the provision of ambulatory care, rather than inpatient care – however important – has presented an array of new issues for existing management teams to tackle.
The most important of these is the emergence of innovative business models and competitors. One very significant aspect of the current environment is that the new entrants generally are avoiding the inpatient business, and are more than happy to let hospitals and health systems operate in that space. These new entrants are instead trying to carve out niches where more nimble, but narrow, expertise can add value via both business tactics and quality of care improvements. In other cases, new entrants are trying to win the hearts and business of patients directly through physician-focused strategies that seek to control costs through commoditization of inpatient business. While there may have been variations of this type of strategy in years past (think ancillary businesses, ambulatory surgery centers, etc.), the new entrants today seem more focused, well capitalized, and are able to leverage technology and data analytics in a way that was not necessarily available a decade or more ago.
The importance of management
In our view, management teams have historically been up to the challenges facing the sector, often by incorporating competitor strategies or entering into joint ventures, while also dealing with shifting governmental policies. For example, most health care providers now have emerging access strategies that include storefronts or urgent care centers, or pharmacy access points. We have noted a great many new joint ventures and partnerships have been consummated to accomplish a wide range of goals, including the importation of new expertise within the provider organizations. As strategies evolve, so do the sets of skills needed to lead key departments, service lines, and strategic initiatives in order to ensure providers have the tools necessary to not only adapt, but thrive.
New technologies will be transformative
One of the important trends that is just emerging is the broad concept of augmented intelligence, which can include machine learning, robotic process automation, and other concepts. To date these efforts have been quite small and have not had any discernable impact on performance. However, it is very high on the list of "ready to emerge" technologies, and when coupled with the vast amounts of data being captured through new and sophisticated information technology platforms, advanced technologies have the potential to be transformative in clinical and non-clinical areas. Initially we expect advanced technologies to have the most material impact from a financial perspective in areas outside of direct patient care. For instance, we are seeing meaningful savings in areas including revenue cycle where rules-based processes can be automated with technology often leading to faster processing in a less costly and more accurate fashion. Over time, many systems are reporting numerous ways that augmented intelligence could assist physicians in broad efforts to improve quality, eliminate unnecessary treatments, and contribute to better cost management over time. We certainly believe advanced technologies will be arriving and making real contributions to performance over the next decade as systems continue to invest in these capabilities internally or through private investment in start-up companies.
Fee-for-service still predominates over value-based care
Separately, the movement to value and the slow pace of that movement has been a fixture of the sector for many years. While a number of providers in select markets have "moved up the value chain," the majority of providers have only dabbled in value business lines but remain very much fee-for-service oriented. While strong and ongoing efforts at controlling expenses have occurred in a great many provider organizations, the underlying cost and at times limited availability of care remain major issues in American life, although access seems to be greater today that at any time over the past 20 years. These and other pressing issues are the catalyst for various solutions debated across the country, including one significant concept - "Medicare for All." The current rise of the Medicare for All movement is best read, in our view, as a grassroots call for addressing the set of affordability, quality, and distribution issues that remain real impediments to access for millions of Americans and at times a hidden tax on all. As insurance availability, which grew meaningfully under the Affordable Care Act, has incrementally declined under the policies of the current administration, and given the legal and legislative threats to the system we have, the imbalances in the current system warrant serious attention. We believe health care remains a critical concern and "Medicare for All" is but one among many potential responses to the complicated issues surrounding the health care sector. However, it is hard to envision a scenario in which any significant piece of health care legislation becomes law, at least in the near term, given the political division at the federal level of government and apparent lack of willingness for real compromise. Nonetheless, we think it is likely that health care will once again dominate the political debate leading up to the 2020 presidential election.
Health care organizations will continue developing population health strategies, expand access points and treat patients closer to home, or in some cases, from home. We are seeing this already play out with the growth of large ambulatory networks, increased physician presence through large primary care networks, and the advent of tele-medicine and other technology-based platforms. One of the benefits from the years of investments made in information technology is access to expansive amounts of clinical data. The new focus point will be harnessing the data into actionable clinical and process improvements. Organizations will be better prepared to address population health strategies, as well as better understand the social determinants to healthy living, and act accordingly to promote wellness. While we recognize that challenges in the health care sector will be the one constant that does not change, we believe the ongoing robust policy debate, innovative ideas and technological advances, and even new entrants and competitors, are just a few of the contributing factors that will help shape the future delivery system.
Providers Will Continue To Chart Their Own Course
Looking beyond one to two years in health care is a difficult task, let alone predicting 10 or 20 years out. We believe the sector is in a transformative period, and the next two decades are sure to include innovations and further technological advances, changes in treatment patterns, and variations in payment models with goals of greater efficiency, transparency, and care coordination. The health care political debate will continue, as will challenges in court to the Affordable Care Act. However, while public policy will always play a major role in the future of health care, and can create an environment that contributes to meaningful change, we believe hospitals and health systems are charting their own course and will adjust to whatever legislative or other changes come their way.
This report does not constitute a rating action.
|Primary Credit Analysts:||Stephen Infranco, New York (1) 212-438-2025;|
|Martin D Arrick, San Francisco (1) 415-371-5078;|
|Secondary Contact:||Kenneth T Gacka, San Francisco (1) 415-371-5036;|
|Research Contributor:||Prashant Singh, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai|
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