Moody’s Investors Service expects that the fundamental business, financial and economic conditions in the healthcare sector will remain weak over the next 12 to 18 months, contributing to its negative outlook for the sector in 2015. (Cash Flow Settling into Low Level of Growth Amid Negative Outlook, 2015 Outlook, Moody’s Investors Service, December 2014)
Operating cash flow will be low, ranging from -0.5% to +1.5% over the next two years. Moody’s attributes this weak revenue growth to a variety of reimbursement pressures and margin contraction related to investments hospitals are making to comply with the Affordable Care Act (ACA) and new reimbursement models.
The 2015 Outlook highlights the following:
Weak operating cash flow growth in 2015 from -0.5% to +1.5%, but more significant declines for smaller hospitals and larger growth for largest systems
Systems with revenue above $2 billion will likely see operating cash flow growth of 3% to 4%; hospitals with revenue under $1 billion will likely generate negative operating cash flow. Operating cash flow growth at hospitals with revenue less than $500 million will decline 2% or more.
Weakening operating margins in 2015
Hospitals have already implemented most of the strategies to preserve margins over the last several years; further expense reductions will be more difficult because: 1) they are operating under two very different reimbursement models, which contributes to margin erosion; 2) labor is the biggest hospital expense yet hospitals view labor reductions as a last resort; 3) physician employment is growing, and physician practices often reduce consolidated hospital margins especially in the first few years of employment; 4) hospitals are making significant investments in electronic health records and other IT systems, and these investments are often expensed in the year they are made and not capitalized, which reduces operating margins.
Low revenue growth but further contraction not expected
Revenue growth has been declining, and will remain low but steady at 3.5%-4.5% over the next several years. Low revenue growth has resulted from many factors including: 1) Medicare inpatient rate increase of 1.4% for federal fiscal year 2015; 2) the Two-Midnight Rule; 3) payer mix shift to governmental payers because of the aging population and the ACA (reimbursement by governmental payers will likely grow more slowly than commercial reimbursement); 4) lower reimbursement growth from commercial payers; 5) decreasing patient volumes because of outpatient growth and inpatient declines.
Uneven impact of ACA; Medicaid expansion states see larger benefit
The ACA’s impact on hospitals’ financial performance has been modest due, in part, to its difficult start and because each state influences actual implementation of the law. There are differences among states that expanded Medicaid eligibility and those that did not. Hospitals in states that expanded Medicaid eligibility and aggressively enrolled individuals for healthcare insurance in 2014 will see the greatest benefit.
Moody’s noted that if projected growth in operating cash flow grows from 0%-3%, it could change its outlook to stable. “Although this growth rate would be very low by historical standards, its steadiness over that timeframe would influence our outlook.” It also noted that a change to a stable outlook could occur if there were a resurgence in hospital patient volumes that compensate for revenue pressure, significant reductions in bad debt, or expansion of Medicaid eligibility in more states.
(iProtean thanks Moody’s Investors Service for allowing us to quote liberally from its publication, Cash Flow Settling into Low Level of Growth Amid Negative Outlook, 2015 Outlook, Moody’s Investors Service, December 2014.)
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