Efficiency, new equity capital enable systems to compete

Because of limited cash, sponsors of some community and religious hospitals have sought to sell or lease their institutions to a not-for-profit (NFP) system or to a for-profit system. A number of national alliances address the capital formation problem of NFP institutions. Until now they have been almost exclusively concerned with acquiring less costly debt. Without new equity capital, market influence is difficult to obtain. Even well-managed voluntary systems face a serious threat from well-capitalized investor-owned systems. Increased competition among hospitals and physicians will force future advantages to those who have capital. It will also restrict funding of certain programs and services by voluntary enterprises. In anticipation of this, various forms of partnerships have developed with investor-owned systems. To regain the initiative as the premier sponsors of health care, religious and other voluntary systems must go beyond merely competing in their markets to acquiring weaker institutions. They also must revitalize private giving and excel in efficiency to offset threats from ambulatory, day-care operations and from high-technology hospitals. Structural changes in the industry can be predicted, including the following: The trend toward integration for production, financing, and marketing will continue. Public market equity capital will be increasingly used to finance medical practice. Hospitals that sell their equity values will establish service foundations. National alliances will continue, but strictly local systems will maintain operation. Investor-owned systems will move increasingly into high-technology tertiary care.     

Regional not-for-profit systems: can they compete with national investor-owned firms?

The relative competitive advantages of regional and national systems are summarized in Figure One. As illustrated, each type of system has unique competitive advantages at the corporate level. While it is difficult to state that either system has distinct advantages that place it in a superior position relative to the other, it seems that in the short-run investor-owned systems have operating characteristics that may result in more efficient internal functioning because of more centralized control over resource allocation and performance systems, greater possibilities for economies of scale, and greater access to capital. However, it was previously noted that growing pressures from government and the business community will lead to tighter constraints on the profitability of investments in the health care sector. The possibility of this shift suggests that the access to capital advantage enjoyed by investor-owned systems may not continue. Additionally, regional systems that are part of larger affiliated organizations such as the Sun Alliance and the Voluntary Hospitals of America are developing means to pool their access to debt funds, thus reducing the cost of capital for member institutions. The group purchasing contracts developed by these large systems also have resulted in significant savings. The distinction between regional and national systems on centralized control are becoming less pronounced. Investor-owned systems are seeking to determine how they might best decentralize selected decisions to be more responsive to local markets while not-for-profit regional systems are recognizing that they must centralize selected decisions to obtain more efficient, rational operation. The long-run outlook suggests that the competitive advantages that have been identified will become less pronounced and that both systems will survive in the marketplace.     

Patterns of financing for the largest hospital systems in the United States

The ten large systems reviewed in this column have greater degrees of financial leverage than do most freestanding hospitals. Larger firms typically have both greater capital access and lower costs of financing. Both voluntary and IO systems make extensive use of variable rate financing, but the percentage of variable rate financing is slightly higher for voluntary systems. This difference may be attributable to larger yield curve spreads for tax-exempt versus taxable securities. Interest rate swaps were used by 70 percent of the systems, but the actual amount swapped was relatively minor. This may change in the future as financial officers become more comfortable and familiar with interest rate swap arrangements. When compared to IO systems, voluntary systems have extensive levels of cash relative to their debt positions. Cash balances are more critical in the bond-rating process for voluntary hospitals, and the ability to raise new equity is much more limited in the voluntary sector. Very little capital leasing was used in any of the systems.     

Hospital profitability and capital structure: a comparative analysis.

This article compares the financial performance of hospitals by ownership type and of five publicly traded hospital companies with other industries, using such indicators as profit margins, return on equity (ROE) and total capitalization, and debt-to-equity ratios. We also examine stock returns to investors for the five hospital companies versus other industries, as well as the relative roles of debt and equity in new financing. Investor-owned hospitals had substantially greater margins and ROE than did other hospital types. In 1982, investor-owned chain hospitals had a ROE of 26 percent, 18 points above the average for all hospitals. Stock returns on the five selected hospital companies were more than twice as large as returns on other industries between 1972 and 1983. However, after 1983, returns for these companies fell dramatically in absolute terms and relative to other industries. We also found investor-owned hospitals to be much more highly levered than their government and voluntary counterparts, and more highly levered than other industries as well.     

Those conversion blues.

With the ever-increasing market penetration of capitated payment systems throughout health care markets, average payment rates for health services have dropped correspondingly. At the same time, the added competitive pressures from managed care organizations have served to increase the demand for new capital investment in information systems, lower cost facilities, and innovative modes for delivering all types of health care services. As a result, many nonprofit health care organizations have converted, or have attempted to convert, to for-profit status in an effort to gain access to the public equity capital markets. As hospitals, Blue Cross and Blue Shield organizations, and other nonprofit health care organizations across the U.S. seek to convert to for-profit status, they are finding the path is not easy. Access to capital, operating efficiencies, and the need to accelerate movement into new markets are offset by public benefit obligations, potential private inurement, and significant political cost issues. The bottom line is whether the conversion will be structured to both protect the public interest and allow the health care organization the flexibility and access to capital it needs in order to continue as a viable, competitive organization into the next millennium.     

Evaluating the underlying factors behind variable rate debt

BACKGROUND: Recent trends show a greater usage of variable rate debt among health care bond issues. In 2004, 63.4% of the total health care bonds issued were variable rate compared with 30.6% in 1995 (Fitch Ratings, 2005). PURPOSE: The purpose of this study is to gain a better understanding of the underlying factors, credit spread, issue characteristics, and issuer factors behind why hospitals and health system borrowers select variable rate debt compared with fixed rate debt. METHODOLOGY: From 2000 to 2004, this study sampled 230 newly issued tax-exempt bonds issued by acute care hospitals and health care systems that included both variable and fixed rate debt issues. Using a logistic regression model, hospitals with variable rate debt issues were assigned a value of 1, whereas hospitals with fixed rate debt issues were assigned a value of 0. FINDINGS: This study found a positive association between bond insurance and variable rate debt and a negative association between callable feature and variable rate debt. Facilities located in certificate-of-need states that possessed higher case mix acuity, earned higher profit margins, generated higher debt service coverage, and held less debt were more likely to issue variable rate debt. PRACTICE IMPLICATIONS: Overall, hospital managers and board members of hospitals possessing a strong financial performance have an interest in utilizing variable rate debt to lower their cost of capital. In addition, this outcome may also reflect that investment bankers are doing a better job in educating senior hospital management about the interest rate savings benefit of variable rate compared with fixed rate debt.     

An examination of contemporary financing practices and the global financial crisis on nonprofit multi-hospital health systems

This study examines the impact of the 2008 global financial crisis on large US nonprofit health systems. We proceed from an analysis of the contemporary capital financing practices of 25 of the nation's largest nonprofit hospitals and health systems. We find that these institutions relied on operating cash flows, public issues of insured variable rate debt, and accumulated investment to meet their capital financing needs. The combined use of these three financial instruments provided these organizations with $22.4 billion of long-term capital at favorable terms and the lowest interest rates. Our analysis further indicates that the extensive utilization of bond insurance, auction rate debt, and interest rate derivatives created significant risk exposures for these health systems. These risks were realized by the broader global financial crisis of 2008. Findings indicate these health systems incurred large losses from the early retirement of their variable rate debt. In addition, many organizations were forced to post nearly $1 billion of liquid collateral due to the falling values of their interest rate derivatives. Finally, the investment portfolios of these large nonprofit health systems suffered millions of dollars of unrealized capital losses, which may minimize their ability to finance future capital investment requirements.     

Competition in health care: strategies from other industries

Health care managers can learn to adjust to competition by observing companies in other deregulated industries. Six basic strategies will separate the winners from the losers: Increase market share. This strategy requires not only increasing the share of current markets but also introducing new products and services into new markets. Scrutinize operations. Managers must be knowledgeable about strategic planning, adept at product line analysis, and skillful in using management information systems. Prune where necessary. Operations must be periodically reviewed to assess whether programs, products, and services continue to be profitable. Increase productivity. Productivity in this labor-intensive industry is essential. Wages may have to be reduced and staffing levels changed in the future to permit better control of labor costs. Increasing the volume of service, investing in nonclinical technology, and encouraging employee ideas also should be considered in seeking higher productivity. Strengthen the balance sheet. Hospitals should avoid incurring both long- and short-term debt, and they should attempt to accelerate repayment of long-term debt. Not-for-profit hospitals should investigate joint ventures, which spread the financial risk among investors, as means to raise capital to expand their operations. Increase cash. Prudent organizations will establish reserve funds, adopt fund-raising programs, and initiate improved cash collection systems. Health care executives also should reflect on how deregulation may affect their employees, the poor, and access to sophisticated medical procedures. The successful health care organization eventually will position itself in line not only with its markets but also with its mission and values.     

Privatization of hospitals: meeting divergent interests

The United States, Germany, and the United Kingdom are experiencing a trend toward the privatization of hospitals--most frequently involving poorly positioned facilities that need: additional capital for replacement of plant and equipment; improved management systems to reduce the number of their nondirect patient care employees; and an aggressive physician recruitment effort. A number of these institutions might have been otherwise shut down, resulting in the loss of good paying jobs; however, these closures would have reduced the nation's total health care expenditures. The acquisition in the United States and Germany by investor-owned hospital corporations of major teaching institutions suggests that the for-profits have become an integral part of their country's health care delivery system. Privatization now even occurs within the egalitarian British National Health Service with the availability of private medical insurance, private hospitals, and private beds in public hospitals being managed by investor-owned groups. Being acquired by a for-profit is often a means to secure needed capital and is politically less fractious than closing down a marginally needed government-sponsored or a not-for-profit facility.     

Capital finance and ownership conversions in health care

This paper analyzes the for-profit transformation of health care, with emphasis on Internet start-ups, physician practice management firms, insurance plans, and hospitals at various stages in the industry life cycle. Venture capital, conglomerate diversification, publicly traded equity, convertible bonds, retained earnings, and taxable corporate debt come with forms of financial accountability that are distinct from those inherent in the capital sources available to nonprofit organizations. The pattern of for-profit conversions varies across health sectors, parallel with the relative advantages and disadvantages of for-profit and nonprofit capital sources in those sectors.     

Assessing the effect of increased managed care on hospitals

This study uses a new relative risk methodology developed by the author to assess and compare certain performance indicators to determine a hospital's relative degree of financial vulnerability, based on its location, to the effects of increased managed care market penetration. The study also compares nine financial measures to determine whether hospital in states with a high degree of managed-care market penetration experience lower levels of profitability, liquidity, debt service, and overall viability than hospitals in low managed care states. A Managed Care Relative Financial Risk Assessment methodology composed of nine measures of hospital financial and utilization performance is used to develop a high managed care state Composite Index and to determine the Relative Financial Risk and the Overall Risk Ratio for hospitals in a particular state. Additionally, financial performance of hospitals in the five highest managed care states is compared to hospitals in the five lowest states. While data from Colorado and Massachusetts indicates that hospital profitability diminishes as the level of managed care market penetration increases, the overall study results indicate that hospitals in high managed care states demonstrate a better cash position and higher profitability than hospitals in low managed care states. Hospitals in high managed care states are, however, more heavily indebted in relation to equity and have a weaker debt service coverage capacity. Moreover, the overall financial health and viability of hospitals in high managed care states is superior to that of hospitals in low managed care states.     

Health care providers under pressure: making the most of challenging times

Whether the slowing economic recovery, tight credit markets, increasing costs, or the uncertainty surrounding health care reform, the health care industry faces some sizeable challenges. These factors have put considerable strain on the industry's traditional financing options that the industry has relied on in the past--bonds, banks, finance companies, private equity, venture capital, real estate investment trusts, private philanthropy, and grants. At the same time, providers are dealing with rising costs, lower reimbursement rates, shrinking demand for elective procedures, higher levels of charitable care and bad debt, and increased scrutiny of tax-exempt hospitals. Providers face these challenges against a back ground of uncertainty created by health care reform.     

Assessing the Differences and Similarities Between Hospital Chains and Independents Regarding Revenues,Profits, and Community Contributions

Hospital systems or chains continue to grow their market share relative to independent hospitals. This trend generates concerns among health care industry observers as historical performance suggests chains charge more for health care services than the independents while providing reduced contributions to their community. This study empirically assesses key performance measures of 67 acute-care hospitals in Virginia by testing if there are differences between chains and independents regarding total patient revenues, revenues per admission, profitability and community support, including charity care, bad debt, taxes paid and Medicaid participation. Implications to industry policy-makers as well as to hospital executives and marketing managers are then presented.     

Health care capital market and product market constraints and the role of the chief financial officer.

To understand better the financial management practices and strategies of modern health care organizations, we conducted interviews with chief financial officers (CFOs) of several leading health care systems. The constraints imposed on health care systems by both capital and product markets has made the role of the CFO a challenge.     

Inner-city hospital closures: financial decision or impediment to access?

This article applies a financial ratio model and a behavioral model of health services use' to examine inner-city hospital closures. We use Medicare Cost Report financial information and demographics to find evidence that hospitals with high debt, less severity of illness, and lower occupancy rates are more likely to close, as expected. We also find that urban hospitals with a high elderly population are more likely to remain open. However, hospitals in our study with a high proportion of Medicare patients and a high minority population are more likely to close. This last finding may have important public policy consequences for access to health care for vulnerable populations, particularly in a recessionary economy under health care reform.     

Master indenture: capital financing for health care systems

The master indenture enables members of multiinstitutional health care systems to finance capital programs and expansions by borrowing on the basis of systemwide revenues and assets. Participation in a master indenture financing may be structured in two ways. In a restricted group, only the parent organization issues notes, and only the parent is directly liable for the debt. To ensure that each member's revenues flow to the parent, the latter must have sole member status and be permitted to approve subsidiaries' debts, budgets, amendments to articles and bylaws of incorporation, and selection of trustees. Each entity's articles and bylaws must permit it to support the system members' common charitable purpose. In contrast, members of an obligated group have direct joint and several liability for master indenture notes. If one subsidiary misses a payment, the parent can call for payment from other obligated group members. Limitations on a member's obligation to support system debt in case of insolvency or bankruptcy may be included in the master indenture provisions. Whichever structure is selected, the amount of debt that can be incurred is based on the institutions' combined financial statements. The master indenture thus allows financially weak institutions to benefit from the credit strengths of stranger system members and permits the parent organization to control members' access to capital markets.     

Hospitals exhibit caution in spending

A recent survey of 290 hospital chief financial officers revealed reduced growth in spending despite increased access to capital. According to the 1992 LINC Hospital Capital Survey, significantly fewer respondents reported their availability of funds was deteriorating (19 percent in '92 versus 27.5 percent in '91). Yet hospitals are exercising caution and appear reluctant to take on large amounts of additional debt. What follows is a portion of the LINC report--an analysis of factors affecting access to capital, as well as the use of funding sources and types of capital projects being funded--prepared by The Linc Group, Inc., Chicago.     

Hospitals and health systems: the best of times and the worst of times

Hospitals and health systems, whether general acute care hospitals or specialty-driven hospitals, are attempting to prosper in a unique time. This year, hospitals throughout the country will see increased reimbursement for hospital inpatient services, rather than decreased reimbursement. Many hospitals are examining a multitude of options for debt financing and a number of the nation's hospitals are in the process of renovating, expanding, or replacing their current hospitals. Further, more private equity and venture capital funds are pursuing hospital investments than seen in several years. Despite the positive signals stemming from many of the country's hospitals, this remains a time of tremendous uncertainty and risk in the hospital industry. This article discusses five strategic and development issues facing many hospitals and addresses how hospitals can prepare for the future should the current climate, supportive of growth, development, investment, and debt financing, change.     

ROI (return on investment): its role in voluntary hospital planning

Return on investment is the primary financial criterion used to evaluate the desirability of capital investment in investor-owned firms. Voluntary health care firms need to examine more carefully their return-on-investment levels. The potential loss of capital cost payment in the Medicare program and the removal of tax-exempt financing would raise the effective cost of capital to voluntary health care firms significantly. Many health care providers might find that they are no longer going concerns if capital costs increase much more.