What makes a health system profitable?

April 25, 2018 / By Kristine Daynes

Gaining or losing? There are mixed messages about the profitability of healthcare delivery organizations. Earlier this year, Modern Healthcare reported that hospitals’ overall operating margins in 2016 increased to an average of 7.7 percent, based on American Hospital Association data. Similarly, many well-known health systems posted profits for fiscal year 2017. That seems to suggest a positive trend for acute care.

However, media reports aren’t specific about why some hospitals and systems are performing well. A closer look at their annual reports can help you understand why some organizations are more profitable than others.

Location. Critical access and rural hospitals struggle more than larger hospital and health systems. In one study, the North Carolina Rural Health Research Program found the profit margin for urban hospitals was 5.5 percent, more than double the margin for critical access hospitals (2.6 percent) and other rural hospitals (2.0 percent).

Integration. Standalone hospitals are becoming rare—at least those who truly work alone. Single-hospital systems that thrive are integrated with ambulatory facilities, physician practices, and community health partners. For example, Monterey Health is a single-hospital system that operates Community Hospital of the Monterey Peninsula, a 38-physician medical group, a fitness and rehabilitation center, and a health plan (Medicare Advantage and commercial members). It participates in a clinically integrated network with another health system and community partners. The successful nonprofit organization generated nearly $51 million in excess revenue to reinvest in services and facilities, even after uncollected revenue of over $1 billion in unpaid bills, bad debt, and charity care.

Process improvement and cost control. Profitable health systems understand that improvement means a change in the way they do things, not simply doing the same things faster or cheaper. For Intermountain Healthcare, cost-effective operations starts with a focus on better patient care through clinical process improvement and supply chain management.

Alternate revenue streams. Not all health system revenue comes from inpatient care. A growing proportion of reimbursement is for care provided in ambulatory clinics and physician practices. And patient care isn’t the only revenue stream. Mayo Clinic, Aurora Hospitals and Clinics, and Aurora’s parent company Advocate Health, reported an increase in the proportion of financial gain from activities outside of patient care—as much as 20 percent of total revenue and gains. These activities include investments (e.g., private equity partnerships, self-insurance trust funds, and acquisitions), reimbursement from risk-based and quality programs, managed care premiums, and retail pharmacy sales.

The financial effect of alternate revenue streams can mean the difference between a little and a lot. Partners HealthCare reversed its 2016 operating loss to post a profit in fiscal year 2017, reporting a gain of $53 million from delivering patient care. That’s a modest profit. The gain was over ten times greater after accounting for investments and income from acquisitions, a net gain of $659 million.

What are the lessons learned by profitable hospitals and health systems?

To better appreciate the success of profitable health systems, it helps to understand first the failings of the U.S. health system at a national level. It is well-known that healthcare spending is higher in the U.S. than other countries, while health outcomes are not. According to analysis by the Commonwealth Fund, there are several reasons the U.S. is not more cost-effective:

  • Overuse of diagnostic testing. Use of medical services and social services in the U.S. are similar to other high-income nations, with the exception of imaging services such as MRIs and CT scans.
  • Higher practitioner salaries. Salaries for U.S. doctors are nearly double the average salary across all high-income countries. Specialists and nurses in the U.S. also earn significantly more.
  • Higher spending on drugs. The U.S. spending per person on pharmaceuticals ($1,443) is nearly twice the average of $749 elsewhere in the industrialized world.
  • High administrative costs. In the U.S., 8 percent of healthcare expenditures pay for activities related to planning, regulating, and managing care, compared to an average 3 percent among high-income countries.

Health delivery organizations have stalled these cost drivers at a local level through a combination of strategies. Several best practices are common among the most profitable health systems in the U.S.:

  • Consolidation of overhead cost centers and streamlined processes to reduce administrative costs, including billing conflicts
  • Elimination of unnecessary medical costs, such as redundant imaging and laboratory services
  • Referrals to cost-efficient providers (e.g., for post-acute care), including alternative therapies with the same or better health outcomes than conventional options
  • Support for process improvement in the form of data, resources, and culture
  • Negotiations for fair pricing of pharmaceuticals and compensation of practitioners
  • Participation in population-based managed care programs such as capitated payment, bundled payment, or other risk-based agreements that reward providers for cost-efficiency and quality
  • Strategic integration with ambulatory facilities, physician practices, and community health partners to reduce unnecessary costs, increase access to primary and specialist care, improve coordination of care, and support better health outcomes

Profitability can sound like an ugly word in healthcare, especially when it is associated with high prices, cheap supplies, and understaffing. Sustainability or cost-effective might be better words to use, because we all want a sustainable and effective system to keep us healthy. Successful health systems accomplish all these things—cost-effective care, sustainable access, fair prices, better health outcomes, and a reliable return to stakeholders who fund the investments.

Kristine Daynes is client engagement leader, Performance Matrix, at 3M Health Information Systems.

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