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Persistently High Unemployment: Dark Days Ahead for U.S. Hospitals

While the effects of persistently high unemployment have surfaced in the shape of reduced consumer spending, shrunken tax rolls and a host of social problems, there is yet another harsh reality lurking in the shadows. Hospitals, already in precarious financial positions, are seeing their most profitable source of revenue fade away. Should the situation continue, even darker days for hospitals will surely be in store.

More than 150 million people in the U.S. rely on employer-sponsored health insurance to pay for the bulk of their medical costs. Hospitals in our country rely on these privately insured and better-paying patients for approximately 35 percent of net revenue. Given the already compressed profit margins in the hospital industry, any deterioration in the supply of its best customers could seriously threaten the financial solvency and operational viability of many hospitals across the country. Health reform will not prevent this from happening. Reform targets the un- and under-insured and provides base level of coverage (Medicaid) and will increase or sustain the number of commercially insured.

While many factors can contribute to the demise of a business, one factor is usually the most difficult from which to recover: a shrinking market for its products or services. Hospitals are happy, or in most cases, lucky, to break even on Medicare and Medicaid patient loads, which generally represent about half of a hospital's cash collections. The battleground for hospitals is the patient that carries commercial insurance that is subsidized by the patient's employer. Such patients pay higher rates than governmental payors, are younger and healthier than most other patients, and often are interested in receiving the most advanced and sophisticated care available, as long as such care is covered by their employer-based health insurance.

According to the American Hospital Association, over the last 20 years U.S. hospitals have generated an average total profit margin of 4.8 percent annually. Many in the industry believe that the hospital payor mix derived from commercial payors accounts for at least 100 percent of the profit figure. So, while any shrinkage in patient supply is detrimental to a hospital's solvency profile, a decline in private-pay patients is much more serious than the loss of other types of patients.

During the same 20 years that hospitals were steadily producing profits, the U.S. economy moved along with the unemployment rate averaging a mere 5.4 percent. Then something strange happened, the country entered the New Economy, again. While the first New Economy was characterized by the Internet boom of the late 1990s, the 2009 version was marked by a boom of its own: an unemployment rate jumping to 10 percent.

The sharp increase in unemployment is only the start of the bad news for hospitals. Almost all of the job losses are from the private sector, which supplies the critical flow of willing and financially able patients hospitals desperately need to make cost-shifting and cross-subsidizing strategies continue to work. Additionally, nobody is forecasting a return to "normal" unemployment rates for at least three-to-five years. As a result, we could be entering one of the most challenging periods ever faced by modern hospitals.

While federal government intervention in the form of COBRA subsidies to individuals has softened the blow so far, these subsidies are expiring. For the millions of people relying on COBRA subsidies as means of affording health insurance, a difficult decision will have to be made once the subsidy ends. As long as unemployment remains high, few of these subsidy-dependent families will be able to find new employment and thus, new commercial health insurance. As unemployment rates persist at current levels, the lack of private-pay patients will exert significant financial pressure on U.S. hospitals. Such declining volumes will be a motivating factor driving horizontal mergers of hospitals, as well as vertical integration of hospitals with physician practices and other providers.

Aggressive consolidation around core competencies, openness to in-market alliances with competitors and the selective use of capital markets (when available) to deleverage and strengthen balances sheets are only a few of the measures necessary for survival after the recent worldwide economic meltdown. For hospitals that fail to plan for the nuclear winter ahead, closures and bankruptcies will follow swiftly. Hospitals and their boards cannot put their heads in the sand and pretend the future will be all right. It will be a different future and one that needs to be planned for today.