Outlook for 1989: high inflation, zero margins, rising wages

Healthcare Financial Management, Jan, 1989 by Russell C. Coile, Jr.

Outlook for 1989: High inflation, zero margins, rising wages

The financial forecast for health care in 1989 is a mixed bag of bad news and good news. There will be challenges and opportunities. The financial "megatrends" for the year ahead will be double-digit inflation; zero margins; wage increases; middle management cuts; patient care growth; improved productivity and product elimination; increased contracting; capital shortages and off-balance sheet financing; managed care growth; and the emergence of chief financial executives.

Double-digit inflation. An old trend returns--double-digit inflation. Health care is caught in a new upward spiral of inflation that will take two to three years to control, despite the efforts of all payers. The hospital component of the Consumer Price Index increased at rates of 11.1 percent for the first two quarters of 1988. The broader medical care market basket rose at 7.9 percent in the same period. Physician costs were up nearly 9 percent and continue to climb. Hospitals will lead the trend into 1989 with price increases of 11 percent to 13 percent on inpatient and ambulatory services.

Zero margins. The average U.S. hospital will break even in 1989, if present trends continue. Half will make money, and half will post losses. Medicare is the largest single factor. As the Medicare payment gap widens, three of four hospitals may lose money on Medicare patients in 1989. Federal budget deficits are driving health policy and spending. Some will beat the odds, despite rising costs and minimal rate hikes from the Healthcare Financing Administration (HCFA).

To the extent that hospitals and health systems anticipated shrinking margins, they may have started making needed cuts in 1988 to achieve 1 percent to 3 percent positive margins in 1989. The top 5 percent to 15 percent of America's health institutions will prosper with high occupancies, expanding ambulatory care revenues, and net operating profits of 5 percent to 10 percent of gross patient revenue.

Wage increases. Labor shortages will boost labor costs by 8 percent to 10 percent in 1989. Hospitals that already raised wage rates by more than 10 percent in 1988 may only pay another 6 percent to 8 percent to stay competitive in 1989, but others that bumped wages by less than 10 percent in the past year will have to play catch-up with bigger increases this year. Wage increases will be given to caregivers across-the-board--not just to nursing. Most regions will experience shortage of physical therapists, pharmacists, and other ancillary personnel. Support staff will get raises of 4 percent to 7 percent.

Middle management cuts. Middle managers will get raises, too, but there will be fewer managers to benefit. Hospitals will thin middle management ranks by 10 percent to 15 percent. Fat corporate offices will go on a diet, with radical cuts. Assistant vice presidents will be especially vulnerable. Nursing management will be targeted for deep cuts.

The staffs of healthcare organizations will get smaller in the year ahead. This can be accomplished humanely and with less damage to morale, if hospitals follow the private sector's experience of early notice, outplacement assistance, and "parachutes" to ease the transition of those cut. Hospitals that resort to surprise layoffs should be prepared for an immediate drop in morale and productivity, followed by an exodus of talented managers.

Inpatient care resumes growth. The five-year decline in hospital's base business of inpatient care ended in 1988. The average length of stay will rise as much as a half-day in 1989 before restabilizing. The bottoming out of length of stay was inevitable. All of the healthy patients have been screened out of the inpatient setting, leaving only the most acute and complex patients.

Patient days will rise 1 percent to 2 percent, and admissions will stabilize in 1989. Many hospitals will experience admissions growth of 1 percent to 2 percent as the population continues to age.

An important watershed change occurred in 1988 as length of stay leveled out: Inpatient volume and profitability are no longer related. Increases in occupancy may mean higher losses, not profits. That means every service, department, unit, and program is its own mini-business. Each service and program has its own customers, payer mix, cost structure, staffing levels, and market strategy.

This creates a substantial increase in responsibility for department heads and product line managers. Many middle managers are not trained for running a small business. They will need support, training, and data. Even with help, a number of middle managers will flounder. Product line management will finally catch on as hospitals and health systems put related services under professional, marketing-savvy management.

Productivity improvement and product elimination. The search for productivity and labor savings will intensify. Labor shortages--not cost savings--will be the catalyst because there will not be enough workers. Hospitals will form "productivity circles," like the quality circles of the early 1980s, on a unit-by-unit basis. A few hospitals may experiment with unit-based performance pay.