Financial outlook stable for U.S. not-for-profit hospitals in 2002 - In the News - Brief Article

Healthcare Financial Management, Feb, 2002

Fitch and Moody's Investors Services, both New York City-based ratings agencies, have projected an overall stable financial outlook for U.S. not-for-profit hospitals in 2002. Fitch believes that cost management, more favorable managed care contracts, and improvements in revenue-cycle management have begun to take hold in the healthcare industry, while continued market forces such as increased labor, pharmaceutical, and supply expenses and growing liability insurance costs challenge sustained advancement. A poor economy also has caused lower investment returns, which are unlikely to subsidize operating losses.

As medical care cost inflation continues to grow, management teams, which already have taken advantage of cost-reduction opportunities, are pressured to increase profitability through revenue-enhancement initiatives, most likely in high-acuity services and payment maximization. These initiatives are more difficult to achieve in competitive markets and poor socioecononomic service areas. Fitch, therefore, believes improved ratings most likely will be seen by providers with strong market positions located in favorable geographic areas with capable management teams. Healthcare organizations located in competitive and economically unfavorable locations will require talented management to improve their credit ratings.

In 2000, operating profitability, liquidity, and capital structure and cash-flow ratios remained relatively flat. Fitch expects operating profitability to be similar in 2001 because most of the same industry pressures still exist. Hospitals in 2002 will face the greatest pressure from staffing shortages, particularly nurses, followed by rising supply expenses. Hospitals also are experiencing increased expenses related to rising liability insurance and property and casualty insurance costs.

Physician practice losses have dropped as most hospitals that employ physicians have implemented productivity-based physician contracts. Also, increased managed care penetration in many markets is less of a concern because many hospitals with strong market positions have achieved some success in renegotiating rate increases, resulting in higher profitability. The Balanced Budget Act of 1997 is in its final year and is no longer viewed as a significant concern, except by teaching hospitals, whose indirect medical education payment cuts remain in effect. Finally, Fitch expects that rising unemployment due to a declining economy could result in a significant increase in the number of Medicaid enrollees. Increases in hospitals' Medicaid payer mix coupled with little potential for growth in state Medicaid budgets could directly affect financial outcomes, according to Fitch.

Moody's projects that not-for-profit hospitals will maintain overall stable credit quality during 2002, compared with recent years when downgrades outnumbered upgrades by almost five to one. Moody's assumes that the slowdown in the U.S. economy will not be as long as most economists predict. The Moody's forecast cites prospective growth in patient volume, improved commercial pricing, and a stable and predictable level of Federal payment for healthcare providers. Several looming risks, on the other hand, could reduce payment to hospitals, and if combined with a sustained period of economic malaise, could result in a possible return to sector volatility and decline.

The most important risk cited by Moody's is the status of Medicare funding following the rapid disappearance of the Federal surplus. In addition, a prolonged economic decline could result in employers rejecting double-digit health insurance rate increases, placing greater downward pressure on hospital payment. Also, hospitals are contending with cost escalation not only for staff compensation and pharmaceuticals, but also for malpractice insurance, utility costs, pension expenses, and bad-debt provisions, according to Moody's. One potential benefit of the economic decline cited by Moody's is the ability to hire a more qualified and affordable nonclinical labor force.

Both Fitch and Moody's issued more ratings downgrades than upgrades in 2001. During the 12 months ended December 31, 2001, Fitch's healthcare group assigned ratings to 66 new issues (versus 42 in 2000), affirmed 49 ratings (26 in 2000), upgraded two ratings (one in 2000), downgraded 21 ratings (19 in 2000), and placed nine ratings on rating watch negative, three on rating watch positive, and one on rating watch evolving. The hospital sector accounted for 18 of the 21 downgrades issued by Fitch, while the nonacute care sector (nursing homes and continuing-care retirement communities) accounted for three downgrades. Fitch expects the number of downgrades in 2002 to continue to outpace the number of upgrades, with fewer downgrades and possibly more upgrades than in 2001. Moody's downgraded 55 ratings worth $7.7 billion and upgraded 22 ratings worth $4.3 billion in 2001, compared with 56 ratings downgrades worth $15 billion and 12 ratings upgrades worth $2 billion in 2000.