At the midway point, stronger financial performance continues

September 5, 2024

By Lisa Goldstein, Managing Director, Kaufman Hall

Kaufman Hall's National Hospital Flash Report showed another month of solid performance through the first half of 2024 with a 4.1% operating margin year to date, continuing a trend of stronger performance that began in late 2023. It's as if a light bulb turned on and has stayed on, setting up 2024 to be a better year than 2023.

Before we declare victory, there are few noteworthy caveats.

First, not all margins are created equally. While the month-over-month median shows improvement, the median change in margin is down, suggesting an uneven distribution of the improvement. About two-thirds of hospitals in the data through 2023 showed no change in operating margin compared to 2019. Many hospitals are running hard but running in place. This means that the improvement in the margin rests on the herculean shoulders of the remaining one third that are doing well - really well, in fact - to drive the national median up.

Second, the Flash report typically reflects only a hospital's acute care operations. If one were to add in physician enterprises and other similar non-acute care operations that negatively impact performance, margins would decline by about 200 basis points. This would bring our Calendar Year 2023 median of 2.7% in line with FY 2023 rating agency medians, which reported breakeven results.

Notwithstanding these caveats, performance through the first half of 2024 suggests much improved results for full 2024. Here are some of the potential drivers.

Volume indicators. Volumes have returned to pre-pandemic levels. Year-to-date discharges through June 2024 are up 4% over the prior year comparable period. At the same time, observation patient days are down materially.

The correlation between discharges up and observation days down may, in part, reflect the rollout of Medicare's Two-Midnight Rule to Medicare Advantage plans on January 1, 2024. The Two-Midnight Rule is a decade-long CMS policy that relies on physician judgment to admit patients as either inpatient (if a stay will be over two midnights) or as an observation case. The Two-Midnight Rule will give CMS more oversight on how MA plans classify care and reimburse hospitals. For example, a service that is on Medicare's "inpatient-only list" must now be reimbursed as an inpatient case by the MA plan, removing MA plans' prior discretion on how to classify these visits. Growth in Medicare Advantage plans has accelerated, with more than half of the nation's Medicare beneficiaries now enrolled in Medicare Advantage plans. The extension of The Two-Midnight Rule and greater oversight of the MA plans comes at a welcome time, given higher denials and extensive pre-authorization reported by many.

Enhanced revenues. Several states are now participating in enhanced supplemental funding programs known as Directed Payment Programs (DPP) or have increased the funding levels of long-standing DPP programs. Some of the DPP programs will bring Medicaid rates, often cited as the lowest reimbursement for hospitals, closer to an average commercial rate. These funds are subject to state and CMS annual approval, making their reliability less certain over the longer term, but they are a meaningful boost to revenues for the time being.

Related, in December, many hospitals received one-time 340B repayment funds from CMS following the Supreme Court ruling that CMS did not properly notify hospitals of a reduction. Revenues were recognized in December or January, a significant tailwind which drove the better performance during those months.

Two indicators will be key determinants in the months ahead:

Revenue and expense trends. Since the start of 2024, revenue growth has exceeded expense growth as measured per patient day. Continuing this financial relationship will be integral to achieving improved results. Even as a not-for-profit organization, hospitals must operate like an enterprise or company where revenue exceeds expenses to ensure financial viability. Labor represents the largest component of hospital expenses. We are not out of the labor woods yet, but many organizations report that contract labor use and hourly rates are down. At the same time, permanent hiring is on the rise, which remains far less disruptive to operations and culture over the long term.

Length of stay. Average length of stay (ALOS) is trending down. After a spike in length of stay during the pandemic, the Flash report shows a 1% decline in ALOS though June compared to the prior year period and a 4% decline compared to 2021, a nod to improved productivity efforts and for some, greater availability of post-acute care beds. The focus on smarter productivity will be important if volumes reverse course and new revenue sources such as DPP are at risk from state or federal budget cuts.

Effective management of daily operations isn't as easy as an "on/off" switch that a lightbulb metaphor suggests. Rather, it's a journey of good planning and tough decisions that are now translating into better results, and better results will allow hospitals to re-invest in the needs of their communities and build a cushion for the unknowns ahead.