More Than Half of U.S. Hospitals Are Now Technically Insolvent or At Risk of Insolvency, According to New Alvarez & Marsal Study
April 22, 2008
Looming Crisis Takes on New Sense of Urgency as Dependence on Sources of Non-Patient Care Revenue Become More Vulnerable in Weakening Economy
New York, NY - More than half of short-term acute-care hospitals in the United States are technically insolvent or at risk of insolvency, according to a recent analysis conducted by Alvarez & Marsal Healthcare Industry Group, part of the global professional services firm Alvarez & Marsal. As states and municipalities begin to limit spending in the face of slumping tax revenues and a weakening economy, the financial health of many hospitals is likely to further deteriorate. Many will encounter serious liquidity crises and face the prospect of radically restructuring or shutting their doors, the report notes.
Among the key findings of the Alvarez & Marsal analysis:
- More than 2,000 of the nation's 4,900 acute-care hospitals do not make a profit treating patients and must rely on alternate and generally unstable sources of funding, including government subsidies and philanthropic contributions.
- Of the hospitals classified as "profitable," approximately 1,000 do not generate sufficient cash flow to fund essential, non-discretionary capital expenses necessary to comply with regulations and/or remain competitive with increasingly dominant academic medical centers.
- Capital expenses in the hospital industry are underfunded by $10-20 billion, largely because capital dollars have been diverted to fund operations.
- The majority of potentially insolvent hospitals are located in urban areas.
- The lack of profit- and performance-based incentives in most hospitals prevents the industry from attracting the management talent that is prevalent in other sectors. In many cases, the complexities of operating a hospital or hospital system overwhelm management and the boards that oversee them.
"The findings of this study underscore the sobering reality that decades of incremental change have not ensured the long-term viability of our nation's hospital system," said George D. Pillari, a managing director in Alvarez & Marsal's Healthcare Industry Group. "With a government safety net becoming less and less reliable and non-patient sources of funding becoming fragile, it has become critical for hospital management and boards to deal with these troubling issues head on and take urgent steps - such as restructurings, mergers or recapitalizations - to improve their finances and allow hospitals to execute on their missions. In the absence of such action, hospital insolvencies will increase and community after community could be forced to grapple with a steady decline in access to care."
"In today's healthcare environment, there are many factors that separate successful and unsuccessful institutions," said Guy Sansone, managing director and head of Alvarez & Marsal's Healthcare Industry Group. "Unfortunately, the gap between the ‘have' and the 'have nots' continues to widen, making early strategic intervention critical in preventing a downward spiral that ultimately ends a hospital's ability to fulfill its mission."
Data, including operating expenses and net revenue, for fiscal years ending in 2005 and 2006 were gathered for each short-term acute care hospital in the U.S. with more than 25 beds. Hospitals with missing data were eliminated, reducing the final sample from 4,510 to 3,861. The sample was then compared to the universe, as published in the American Hospital Association's directory, Hospital Statistics, to ensure the sample was representative and unbiased.
The analysis focused on two key measures of hospital performance: patient care margin (i.e., net patient revenue less operating expenses divided by net patient revenue) and EBITDA margin (net income + depreciation + amortization + interest + taxes) / operating revenue (net patient revenue + all other revenue). To minimize the effects of unusually good or unusually bad years of financial performance, average values of the metrics for 2005 and 2006 were used.
- Patient Care Margin less than 0.0 percent - If a hospital cannot earn a profit on its patient care services, it must rely on non-patient care sources of funding to remain viable. Hospitals not earning a profit on patient care will become insolvent when they can no longer sell or borrow against assets, or receive emergency governmental aid to fund losses.
- EBITDA Margin less than 4.0 percent - A minimum level of profit and cash flow is required for a hospital to fund daily expenses and re-invest in necessary, nondiscretionary capital expenditures. Capital investment needed to remain competitive is estimated at 6.0 percent to 8.0 percent of annual operating revenues. This analysis identified a level of 4.0 percent as the minimum level of profitability for a hospital under pressure to fund day-to-day activities, as well as a "survival" level of capital expenditures.
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