U.S. acute care hospitals are facing the perfect storm of fiscal pressure due to the coronavirus pandemic: sharply lower revenues due to cancelling as many elective and non-emergency procedures and visits as possible to preserve capacity for a surge in COVID-19 cases; likelihood that reimbursement for COVID-19 cases won’t be as favorable as it is for the business that it replaced; rising costs for scarce supplies such as masks, personal protective equipment, and ventilators; and growing costs for staff, including overtime and backfilling for staff that have become ill, are self-quarantining, or caring for family members at home. Additionally, the value of hospitals’ cash reserves has declined due to the market’s recent swoon, the cost of borrowing has risen, and those with defined benefit pension plans will see their net pension liability increase. The depth of financial challenges for hospitals will vary depending on the outbreak’s geography, length, severity, and the hospital’s financial strength pre-crisis, but in almost all cases, the financial impact on hospitals will be negative.
Against this backdrop, all three of the major rating agencies – S&P Global Ratings, Moody’s, and Fitch Ratings, have revised their outlooks on the nonprofit healthcare sector to negative. S&P cited their belief that the pandemic would cause “sizable increases in operating costs, particularly for labor and supplies, reduced volume and revenues related to elective and non-essential healthcare needs, reliance on working capital lines of credit, and material declines in unrestricted reserves and non-operating revenue as the investment markets weaken”.
Environment Was Already Challenging for Acute Care Hospitals
These pressures occur on top of an environment that was already challenging for hospitals, including staffing shortages, growing pharmaceutical costs, policy uncertainty, changing consumer expectations, and greater competition from nontraditional providers such as CVS Health (created from the merger of CVS and Aetna). As a result of these pressures, many hospitals have merged and some have closed. Hospital closures have hit rural America particularly hard – there have been 118 rural hospital closures in the last decade, according to healthcare consulting firm Stroudwater Associates. In changing its outlook on the sector to negative, S&P Global noted “These added constraints have come at a time when organizations were already under some revenue and expense pressure”. Their former stable sector outlook relied heavily on the strength of hospital balance sheets, which had been buoyed by several years of strong investment market returns, much of which has now evaporated.
For the many U.S. hospitals that were already operating on thin margins or have little in cash reserves, the COVID-19 crisis could quickly become an existential issue without sizable and immediate help. It remains to be seen if the Coronavirus Aid, Relief and Economic Security (CARES) Act will be enough to offset the operating pressure on hospitals and whether the aid will come quickly enough. Some hospitals have already started to furlough staff to stem the red ink.
Maryland’s Unique Payment System Provides a Cushion
For Maryland hospitals, the situation is far from rosy, but it also isn’t quite as dire as for hospitals elsewhere. Maryland hospitals face the same expense pressures from the COVID-19 crisis as their brethren in other states. However, Maryland has a unique reimbursement system that provides its hospitals a substantial revenue cushion against declining volumes. For about 40 years, Maryland’s hospitals have operated under a “waiver” granted by the Centers for Medicare and Medicaid Services (CMS), which allows the state to set hospitals rates for all payers. The model employed to implement the waiver has changed several times over the years, always with the goal to restrain growth in the cost of care while providing high quality outcomes. The latest version, called the “Total Cost of Care” model, started in January 2019. Under the model, the state’s acute care hospitals each operate under a hospital-specific Global Budget Revenue agreement with the state’s rate setting commission.
To simplify what is in reality a very complex system, each hospital’s total annual revenue is known at the beginning of each fiscal year. As hospitals provide services to patients, they charge the payor amounts that are designed to achieve the total global revenue budget amount by year-end. So when patient volumes drop, the hospitals actually charge more per unit of service, and when volumes rise, they charge less. All this is designed to give hospitals an incentive to manage the total cost of care for patients and avoid some of the perverse incentives of the fee-for-service system used around the country, where hospitals are generally paid for each visit, procedure, or stay, and are thus incentivized to do more.
Under the Global Budget Revenue system, Maryland hospitals are incentivized to help patients get better, stay healthy and avoid future care, something that generally isn’t the case in other states. Although many hospitals nationally are involved with various programs designed to transition their incentives from “volume-to-value”, the Maryland program is the boldest and most comprehensive volume-to-value experiment. There are varying views about whether the Maryland system actually saves money and provides better outcomes. A recent evaluation from CMS was generally quite positive while other views have been more ‘meh’.
But regardless of policy debates about the effectiveness of the Maryland hospital payment model, it is providing some downside cushion to its hospitals in the current environment. Like other hospitals around the country, Maryland hospitals have cancelled elective and non-emergency visits and procedures. Many hospitals are reporting volume declines of 30-40% as a result, especially where COVID-19 cases haven’t yet surged. For hospitals outside of Maryland who generally are reimbursed only for care provided, a volume drop that sizable, while necessary for public health, can be financially disastrous.
Maryland hospitals, however, are still expected to be able to recoup most of the global revenue budget through raising rates per unit of care as volumes decline. Maryland hospital revenues may not be completely protected because the global budget agreements generally provide for a “corridor” to raise or lower rates as volume changes, usually about 10%. So if volumes drop by 30% for example, a hospital will not be able to raise unit rates 30% to recoup the entire loss. But still, the corridor is a substantial cushion that hospitals outside the state don’t enjoy. Furthermore, the state’s rate setting commission is highly aware of the need to maintain the strength and viability of the state’s hospitals and has many policy tools it can use to ease the pain for its hospitals. For example, it could decide to temporarily increase the size of the corridors or allow hospitals to carry over revenue they were unable to charge this year into a future fiscal year. These are policy tools that other states don’t have, where rates are individually negotiated between each hospital and payor.
Employed Physicians Are Not Protected Under Global Budgets
While hospital-based revenue is somewhat protected in Maryland due to global budgets, physician revenue, often called “professional billing” in healthcare jargon, are not part of the agreements, even when the physician is employed by the hospital. Physician fees are billed separately and are based on fee-for-service arrangements. So as hospitals have purposely emptied out their facilities by cancelling cases, and patients have cancelled outpatient appointments voluntarily, physician incomes are plummeting, at just the same time that we as a nation are coming to understand how heroic and necessary their services are. This dynamic is true around the country, including Maryland, and the CARES Act doesn’t appear to have a lot of provisions to cushion financial losses for physicians.
For hospitals including those in Maryland that employ physicians, to the extent they choose to protect their employed physicians’ incomes, and many of them will, the hospital will absorb the loss. This will partially offset the benefit of the revenue cushion that Maryland hospitals have under their global budgets, but compared with hospitals around the country that don’t have that cushion, Maryland’s ability to absorb physician practice losses will be more sustainable.
Will Lenders and Institutional Investors Differentiate Maryland Hospitals?
About three-fourths of U.S. hospitals are nonprofits or owned by local governments. These entities borrow in the municipal debt market, which has reacted quickly and violently to the COVID-19 crisis. Municipal bonds have been hit hard in the last few weeks as investors sold bonds, pushing prices down and yields up. After 5 years of consecutive monthly inflows to municipal bond funds, investors pulled a record amount out during March, forcing portfolio managers to sell bonds to meet redemption demands. As organizations have clamored for additional liquidity in the face of unprecedented revenue declines, banks have raised fees for access to lines of credit. While there are recent signs of some moderation in the market, the cost of new borrowing has gone up measurably just since the beginning of March.
Furthermore, when investors are in a headlong rush for the exits as they were in mid-March, they don’t always have the time or sufficient information to differentiate more resilient borrowers from those that are more vulnerable. This can make it harder for the better organizations to access capital at reasonable cost, if they can access capital at all.
With the news about financial risks for hospitals getting more dire by the day, it is unclear if investors will differentiate Maryland hospitals from others around the country. Investors and lenders can begin to differentiate by understanding the Maryland rate setting model, which aspects of the national fiscal pressures will apply to Maryland hospitals, to what extent the rate system will moderate those pressures, and the policy tools that the rate setting commission may choose to employ to ensure the viability of the state’s hospitals in this extraordinary time.
The author is a board member of the University of Maryland Medical System (UMMS), one of the largest healthcare systems in the mid-Atlantic. UMMS’ hospitals operate under global budget revenue agreements and UMMS has debt outstanding in the municipal debt market. The author is also President of Nutshell Associates LLC, a municipal advisory and consulting firm, and a faculty member of the McDonough School of Business at Georgetown University.