Can Hospitals Survive? Part II

In 1980, while working at the University of Chicago Pritzker School of Medicine, I wrote an article for the Harvard Business Review entitled “The Health Care Market: Can Hospitals Survive?”. This article, and the book which followed, argued that hospitals faced a tripartite existential threat:

1)  ambulatory technologies that would enable physicians to compete successfully with hospitals at lower cost in their offices or freestanding settings, 2)  post-acute technologies that would enable presently hospitalized patients to be managed at home and 3) rapidly growing managed care plans that would “ration” inpatient care and bargain aggressively to pay less for the care actually provided.

I predicted a significant decline in inpatient care in the future, and urged hospitals to diversify aggressively into ambulatory and post acute services.   Many did so.  A smaller number, led by organizations like Henry Ford Health System of Detroit and Utah’s Intermountain Health Care, also sponsored health insurance plans and became what are called today “Integrated Delivery Networks” (IDN’s).

In the ensuing thirty years, US hospital inpatient census fell more than 30%, despite ninety million more Americans.   However, hospitals’ ambulatory services volume more than tripled, more than offsetting the inpatient losses; the hospital industry’s total revenues grew almost ten fold.

Ironically, this ambulatory care explosion is now the main reason why healthcare in the US costs so much more than in other countries.  We use far fewer days of inpatient care than any other country in the world.  But as the McKinsey Global Institute showed in 2008 ambulatory spending accounts for two thirds of the difference between what the US spends on healthcare and what other countries spend, far outstripping the contribution of higher drug prices or our multi-payer health financing system.

Hospital Revenue Growth Comes to an End

Hospitals’ long run of uninterrupted revenue growth has come to an end.  An advanced warning of problems was the cessation of growth in hospitals’ ambulatory volume-  from better than 7% in 1995 to scarcely more than 1% by 2010-2011,  according to the American Hospital Association.   Additionally, inpatient admissions, which briefly spiked upward from 1997 to 2003, began a second leg of decline in 2009, with hospital inpatient volumes down for the last five years.

CitiGroup’s monthly tracking survey suggested that hospitals lost about 4% of their admissions in 2013.  In addition, hospitals are generating low single digit revenue increases.

The resulting dearth of top line revenue growth in the face of continued growth in expenses has catalyzed a spreading wave of hospital layoffs.  What is interesting about these layoffs is that market-leading institutions-from the Cleveland Clinic to Indiana University Health and St. Vincent in Indianapolis to KentuckyOne in Louisville to INOVA in DC to Vanderbilt University- are reducing their staff, suggesting that even a commanding market presence hasn’t prevented cash flow from drying up.

Has Health Reform Played a Role?

Some observers believe the Affordable Care Act has helped slow hospital use.  Health reform may indeed have played a role, but not in the way analysts have suggested thus far.  Non-ACA changes in Medicare policy and a raft of other factors have probably played a larger role.

For example, reduced readmissions may have contributed perhaps 130 thousand  avoided admissions to the 2013 decline.   But against a base of 34 million plus admissions, this is a barely noticeable four-tenths of a percent reduction.  ACO’s, another possible driver, cover not even 6% of the US population.  No-one has yet quantified ACOs’ effect on hospital admissions, but it is likely to be even smaller.

On the other hand, a concerted push by Medicare to reclassify sub-acute admissions as observation stays (which accelerated last October with the ill-fated “two midnights” rule from CMS) may have had a bigger impact on reducing acute admissions than anything in ACA.   Since 2004, observations stays per Medicare beneficiary have grown 34% while acute admissions per beneficiary have declined by almost 8% .

The ACA’s hospital payment reductions (0.5% a year in DRG updates) seemed minuscule in the first couple of years, but the  cumulative effect on hospitals’ revenues, when added to the 2% reduction from the sequester, has unquestionably damaged hospitals economically.  And for hospitals in the two dozen states that elected not to expand their Medicaid programs,  the ACA’s cut in disproportionate share (DSH) payments has been a gratuitous additional source of damage.

However, health reform’s most significant effect on hospitals may be ACA’s soft caps on health plan rate increases.     Insurers have clamped down hard on their hospital contract renewals, even for “unavoidable” institutions like major teaching hospitals and regional IDNs.  This is because they expect to be unable to increase their own revenues to compensate for any future rise in claims costs.  Double digit rates increases have disappeared.

Despite all these regulatory impacts, the fact that the momentum changes in inpatient admissions began in 2003 and for outpatient volume in 1995 argue that other factors have been at work than the fairly recent political ones.   Beyond those mentioned above, the main drivers of the spreading topline weakness for hospitals include:

–       a dearth of new ambulatory technologies that would attract additional patients

–       a sharp cost-shift in health plans toward patients (as enrollment in consumer directed health plans have quintupled since 2007 to over 30 million),

–       the emergence of radiology benefits managers who reduce discretionary imaging use

–       the gearing down and retirement of the entrepreneurial generation of baby boom physicians

Entrepreneurial Boomer Docs Gear Down

The  generational change in medical communities has been underestimated as a potential contributor to the hospital revenue slump. Seventy hour a week entrepreneurial baby boomer docs are retiring and are replaced by frightened, debt-burdened 35 hour a week Gen Y salaried docs.  The baby boom docs began reaching retirement age co-incident with the 2003 slowdown in hospital admissions.  However, many of them were trapped short of retirement by the 2008 stock market crash and freezing of the medical real estate market.

Long before the crash, many baby boom physicians had already, as one of them put it, “taken their foot off the gas”.  They began withdrawing from hospital practice, and insisting that hospitals hire hospitalists to manage their patients.   Elliot Fisher’s 2006 ACO paper noted that 38% of physicians in their national sample had no Medicare hospital billings (sampled in 2002-2004).  That number is certainly higher now.

The result of gearing down of older physicians’ practice activity is that a shrinking percentage of hospital admissions is coming from community docs. A steadily rising percentage of admissions are passing through hospital emergency rooms.  Some 70% of admitted Medicare patients came through the ER in 2011 according to MedPac .

Hospital Strategic Response.

Some hospital managements have responded to the deepening slump with a frenzy of deal-making: merging with other hospitals into larger enterprises that the bankers and consultants have assured them will have “economies of scale” and leverage with payers.  Hospital merger activity doubled in the wake of health reform and continues rising.

Hospitals are also attempting to offset the declining growth in ambulatory volume by buying up the practices of formerly independent physicians and incenting them to use the hospital’s ambulatory services.    According to AHA, the number of docs employed full time by hospitals rose 50% from 2003 to 2012, to about 100 thousand (not counting interns and residents).   According to MGMA, hospitals lost an average of  $206 thousand per employed doc in 2012 (the difference between guaranteed salary and other practice expenses and collected revenues) and many are not generating enough new ambulatory services volume to offset these losses.

The physician practice losses, euphemistically called “physician investments”, are compounded by rising payments for physicians taking night or weekend call in ER’s and ICU’s, medical directorships and other forms of physician subsidy.  Income subsidies to physicians have become hospitals’ fastest growing expense. Today, hospitals’ most urgent cost management challenge is to reduce physician subsidies that serve no strategic purpose.

“It’s Either Make Deals or Run the Business”

Both the merger and practice acquisition booms are questionable long-term strategies.  They also come with a steep opportunity cost.  As one Wall Street analyst said on CNBC last year:  “It’s either make deals or run the business.”  It’s pretty much impossible to do both at once, particularly as the hospital business is changing due to the insurance market and payment reforms accelerated by ACA.

Health reform could add another twelve million folks to the 30 million that already have high deductible coverage. .  It is possible that by the end of the next recession, as many as triple the current 30 million people will be in high deductible plans.   Those plans sharply raise the out-of-pocket cost of using the hospital, our most expensive healthcare site    A sign that this has had an effect:  most hospitals report their sharp rise in bad debts during and after the recession came from insured patients who could not pay their share of the bills.

But the emergence of narrow or tiered networks will have a more significant effect on hospitals- by further reducing hospital bargaining leverage with health plans.    For example, as a Medicare Advantage subscriber, I don’t need every hospital or specialist in the region in my health plan’s network- only my doctor, the hospital he uses and the key specialists I’m likely to need and their hospital(s).    My narrow network MA plan was $4000 a year less expensive than the Medicare supplement plan that would have provided me access to everyone.  Even for a fortunate baby boomer, it just wasn’t worth $4000 of out-of-pocket premium expense to have maximum access.

Hospitals that pursued market consolidation strategies (merging with in-town competitors, for example) will find health insurers raising the out of pocket cost for access to them, and LOTS of patients trying to avoid them, because they have grown so expensive. That means that hospital strategy will have to shift, not only because of value-based purchasing incentives to reduce care defects, readmissions, etc., but because consumer choice based on value will increasingly drive hospital volumes.

Creating value for consumers will require something approaching a revolution in hospital management- whose vanguard we can see in institutions like Virginia Mason and ThedaCare that have adopted patient-centered LEAN operating principles.   Hospitals that spent the last decade working to become “unavoidable” may have trouble refocusing on what patients and their families really need- affordable, reliable and compassionate care.

What Am I Advising Hospitals To Do:

Eliminate Layers of Management between the Patient and CEO

Empower Front Line Caregivers to Eliminate Waste, particularly of Time

Eliminate Avoidable Medical Errors and Care Defects

Smooth and Light the Patient’s Pathway through the Care Episode

Become the Hospital of Choice in Their Communities and Regions

While policymakers continue to debate whether the lengthening pause in overall health cost growth will continue, I believe the hospital contribution to that pause is not “temporary”, but represents a fundamental shift in the hospitals’ position in a tightening health care market.   Coping with this sea change will require a completely different set of competencies, as well as a fundamental change in management philosophy.

Originally published on The Health Care Blog.