The Health of Our Nations Hospitals
Executive Summary
How did the healthcare industry fare in 2004? To answer that question, Solucient® reviewed essential measures of the U.S. healthcare systems financial strength from 1997 to 2004, including hospital operating margins and other operational indicators.
Overall, Solucients data show hospitals continuing to post lower operating margins since the Balanced Budget Act of 1997. Possible factors contributing to this trend include reductions in reimbursement; rapidly rising operational costs, due in part to pharmaceutical supply expenses; higher salaries paid to attract increasingly skilled workers; increases in health insurance benefit expense; and increased bad debt expense.
In 2004, Solucients findings indicate that hospitals faced a particularly challenging situation: decreasing operating margins combined with steadily increasing costs of operation. The operating margin for the average hospital in 2004 was 4.04%, a decline of 20% from the 5.05% average operating margin in 2003. This low level of financial performance suggests a continued long-term risk for the sustainable operation of many U.S. hospitals.
Quarterly trends related to operating margin have changed, too. From 1997 to 2002, operating margins typically peaked in the first quarter and then dropped sometimes significantly by the second quarter. In contrast, during 2003 and 2004, the second quarter was the period of strongest financial performance. Among other key findings:
- All bed-size and regional groups recorded weaker operating margins in 2004 than in 2003.
- Large hospitals (300 beds or more) regained the lead in average operating margin in 2004 by achieving a level of 4.25%.
- Regional variations in case-mix-adjusted length of stay underlined regional differences in the cost of operations and operating margin. Median length of stay in 2004 for the Northeast region was 4.32 days, compared to a median of 3.89 days for all hospitals. At the same time, the Northeast region operating margin averaged 2.86%, compared to the 4.04% average for all hospitals.
- The North Central and South Atlantic regions performed better than average in 2004, with average operating margins of 5.15% and 4.38% respectively.
- The average adjusted occupied beds measure for the average hospital remained steady from 2001 to 2004.
- Average cost per adjusted discharge continued to rise, increasing to $7,041 for all hospitals in 2004, including a 4.9% gain in 2004 alone.
- Total spending on capital as a percent of total operating expense maintained a steady decline.
Operating Margins Suggest Long-Term Risk
The average hospital operating margin retreated from improvement shown in 2003, reaching its lowest level since 2000 and its third-lowest level since 1997. (See Figure 1.) Operating margins hovering around 4% suggest a potential long-term risk for many facilities.
Average hospital total margins reflect a similar trend to operating margins. Historically, total margin has contributed an additional 1.5% to 2% above operating margin. (See Figure 2.)
From 1997 to 2002, the strongest financial performance was consistently achieved during the first calendar quarter of the year. However, a new trend may have started, with the best financial results occurring in the second quarter in 2003 and 2004. Note that the linear regression line illustrates an overall downward trend. (See Figure 3.)
Small hospitals fewer than 150 beds have traditionally recorded higher operating margins than mid-sized or large hospitals, posting the highest percentage every year from 1998 through 2001. Since then, the group attaining the highest operating margin has alternated between small and large facilities. In 2004, hospitals with 300 beds or more regained the lead with an average operating margin of 4.25%, compared to 4.11% for small hospitals and 3.8% for mid-sized hospitals. (See Figure 4.)
Regional Trends Changing
Historically, hospitals in the West have been among the strongest financial performers. This trend was reversed in 2004 with the average operating margin for the West region declining dramatically to 2.79%, less than half of the regions 2003 average margin of 5.73%. Although declines were less dramatic in other areas of the country, all regions performed more poorly on average in 2004 than in 2003. Declines in average operating margins for other regions from 2003 to 2004 were South Central, -19.2%; Northeast, -14.9%; North Central, -9.3%; and South Atlantic, -8.6%. (See Figure 6.)
From 1997 to 2004, the North Central region posted consistently strong results with an operating margin averaging 5.24%. Averages for the other regions during the same eight-year period were West, 4.88%; South Atlantic, 4.61%; South Central, 3.14%; and Northeast, 2.8%.
Median LOS Down; Median CMI Up
While average operating margins have dropped, length of stay (LOS) has shown a slow but steady decrease during the past eight years. In 1997, the median LOS for all U.S. hospitals was 4.89 days; in 2004, the median was 4.75 days. The median case-mix index (CMI) increased slowly and steadily over the same time span. In 1997, the median case-mix index for all patients was 1.118; in 2004, the case-mix index was 1.219.
Adjusting LOS by the case-mix index yields some interesting results. Four regions were tightly grouped around the all-hospitals median LOS of 3.89 days. However, median LOS in the Northeast region was 4.32 days, about 11% higher than the all-hospitals median. (See Figure 7.)
Utilization of Services Stablizes
The adjusted occupied beds indicator represents utilization of inpatient and outpatient services. Inpatient occupied beds are increased to reflect outpatient services by a charge adjustment.
After demonstrating regular increases in volume from 1997 to 2001, average adjusted occupied beds for the average hospital have remained steady. (See Figure 8.)
Average Cost per Adjusted Discharge Grows
As U.S. hospitals post lower operating margins, they continue to experience higher average costs per adjusted discharge. These increases are not related to declines in volume; rather, they represent significant increases in the cost of operations. Since 1997, the cost per average discharge for all hospitals has jumped by 32.8%, including a 4.9% gain in 2004 alone. (See Figure 9.)
Similar trends in cost per adjusted discharge are reflected in national hospital groups classified by bed size. Note that hospitals with 300 beds or more have experienced the greatest increase in these costs since 1997. (See Figure 10.)
Geographically, providers in the West and Northeast regions had the highest average discharge costs in 2004. To address differences in wage rates, the labor portion of total operating expenses was adjusted using the area wage index. (See Figure 11.)
Capital Spending Continues to Dip
Total spending on capital as a percent of total operating expense has continued to trend steadily downward. In 1997, capital spending for the average hospital represented 9.02%. By 2004, this had decreased to 6.77%. Mid-sized hospitals exceeded this overall average, with capital spending at 7.44% in 2004. (See Figure 12.)
Conclusion
Pressures on hospital operating margins show no signs of abating. Reduced reimbursement, coupled with an increase in bad debt, will force hospitals to find new ways of reducing operating expenses while maintaining quality of care.
The data presented here summarize a few of the leading indicators in the industry. As is true with any summary, it may raise as many questions as it answers. Solucient will continue to monitor and analyze these trends to assist providers in better understanding the current environment and its challenges.
Methodology
Solucient analyzed data provided by more than 750 hospitals participating in its ACTION O-I® program. That data was correlated to Medicare cost report information and then weighted so the averages described in this report reflect the average experience of all U.S. hospitals.
The average operating margin percentage is a profitability ratio that measures the percent of revenue (generated from patient care services) remaining after all related expenses are taken into account. Operating margin is calculated as the difference between total operating revenues and total operating expense divided by total revenue.
About ACTION O-I
With financial and operational data from more than 750 healthcare organizations across the country, Solucients ACTION O-I® program has unmatched breadth and depth of data, making it the industrys largest, most comprehensive and timely source for comparative analysis. ACTION O-I allows hospitals and health systems to compare operational and financial data and target key areas for cost control and performance improvement.
About Solucient and Thomson Healthcare
Solucient is a part of Thomson Healthcare, the leading provider of decision support solutions that help organizations across the healthcare industry improve clinical and business performance. Thomson Healthcare products and services help clinicians, hospitals, employers, health plans, government agencies, and pharmaceutical companies manage the cost and improve the quality of healthcare.
Thomson Healthcare is a part of The Thomson Corporation, a provider of value-added information, software tools and applications to professionals in the fields of healthcare, law, tax, accounting, scientific research, and financial services. The Corporation's common shares are listed on the New York and Toronto stock exchanges (NYSE: TOC; TSX: TOC). For more information, visit ( www.thomsonhealthcare.com ).
