Value-based Care is Ripping Into Health System Profits

Large health systems and hospital operators are reporting falling profits, revenue, income, and share value. The promise of population health management may eventually restore financial order, says one industry expert.

This article was originally published on March 10, 2016.

It has not been a good revenue year so far for health systems and hospital operators. Some of the largest players report massive slides in profits and stock prices.

The good news, analysts say, is that health systems will see a turnaround once the industry more fully adopts the value-based care model.

The bad news is that probably will take a while.

In February, the 2015 annual and fourth quarter financial results from Kaiser Foundation Health Plan, Kaiser Foundation Hospitals, and its subsidiaries showed a $1.2 billion drop in profit year over year. Kaiser's net income was $1.9 billion in 2015, compared to $3.1 billion in 2014.

Community Health Systems, the country's second-largest chain of for-profit hospitals, also reported falling revenue. On February 15, the company's stock fell 22% to $14.53 and had dipped as much as 31% to $12.86, marking the lowest intraday price for Community Health since December 2008.

Community's shares lost more than 75% of their value since hitting a 52-week high of $64.04 on June 26, 2015. Tenet Healthcare also reported in February that its financials were down 5.9% at $22.58.

The falling profits are a side effect of the healthcare industry's move to value-based care, says Jeff Hoffman, senior partner and health care strategist in the global management consulting firm Kurt Salmon's Health Care Group.

"This is an awkward and ironic in-between time. The shift to value-based care tasks hospitals with reducing the number of procedures or inpatients for which they now receive payment and instead be pre-paid or receive a risk payment," Hoffman says. "That's not traditionally a recipe for profit growth. But there are ways to make it work. There just aren't any fast solutions."

Industry in Transition
Reimbursement shifts are taking longer than most providers expected, Hoffman notes. Most are focusing attention on the expense side, he says, removing unnecessary procedures and imaging, and developing protocols for better and more efficient care. Some of this does have a negative revenue impact, as well, he notes.

Providers are investing in value-based care delivery models, but the large payoffs on any significant scale haven't come yet, Hoffman says. Meanwhile, new technologies to improve care and patient access, such as telemedicine, cost money. Providers are also buying primary care medical groups and refocusing their processes and protocols to create narrow networks that serve defined populations.

That's a huge expense that will continue to drain health system resources, whereas achieving real value under population health models remains elusive for many as health systems struggle to manage chronic patient populations and transitions into, and from, post-acute environments, he explains.

"Remember that one of the major goals of value-based care is to improve the outcomes and reduce the total cost of care as well as each individual episode of care. And ironically, it costs a decent amount of money and significant time to set up the health partnerships and technologies to make that work," Hoffman says. "So for a long time, healthcare providers will be trying to reduce the number of customers they have and how much those customers pay. That's not a recipe to increase profits."

But once those base investments are made, Hoffman says, health networks can start driving new sources of revenue, use data analytics to target care to individuals who use an outsized amount of the network's resources, and even create their own insurance plans or partner with insurers to target their narrow network populations. That's the promise of population health management, which is distinct from value-based care and which most providers won't achieve for some time, if at all, he says.

"So we're unlikely to see profits jump back up in the near term, but once the leading healthcare entities start diving into capitated risk models, we will see those organizations finding new ways to drive profits in the new value-based health care paradigm," Hoffman says.

Pressures Mounting on All Providers
The falling profits are not surprising in light of the ongoing reimbursement pressure and increasing competition, says Chad Sandefur, a director and healthcare analyst with AArete, a management consulting firm that helps companies increase profits without reducing headcount.

"The top line is affected by challenges in reimbursement, whether that comes from CMS or the new contracting mechanisms in the market. The portion of receivables from Medicaid also affects the quality of the top line," Sandefur says. "Added to that are various incentives and penalties regarding value-based purchasing, readmissions, quality indicators. When you factor in that up to 10% of reimbursement from Medicare can have a penalty associated with it, you're going to continue to see a challenge to the top line."

All sectors are affected by those pressures, but Sandefur says the impact may be greatest on independent or community-based facilities that have not aligned with larger healthcare systems, urban facilities that have a large Medicaid population, and children's hospitals that traditionally have been supported largely by foundations. For-profit health systems usually have the advantage of greater size, which gives them the ability to negotiate favorable terms in the market and to more easily absorb financial setbacks, Sandefur says. They also have the capital to invest infrastructure, such as IT systems and standardized purchasing, that allow them to be more efficient and squeeze every penny out of their reimbursement.

Nonetheless, the recent profit slides from Kaiser and other big players demonstrate that no one completely escapes these pressures, Sandefur notes.

More of a Reset Than a Trend
Successful health systems with regional strength will turn the tables on payers, Hoffman says, and set the terms for narrow networks and direct-to-employer contracts to secure and grow share, manage appropriate utilization, and take more risk—and share—of the premium dollar.

Hoffman doesn't think the drop in profits is a trend so much as a reset. Healthcare providers need to adapt to the reality that no hospital, no doctor, and no medical device manufacturer or pharma company will be able to charge what they previously could, he says. Every player in the healthcare industry is now tied into this new paradigm where value must be defined and measured before anyone is compensated.

"Will we see some players grow, gain market share, justify that value, and increase profits? Absolutely. In high-population centers, for example, health systems that embrace retail, digital and telemedicine platforms will realize big gains in brand value and set the stage for essentiality to shift from physical assets to service and results," Hoffman says. "But the industry overall cannot sustain the costs it's seen to date."

Hoffman expects provider merger/acquisition and partnership activity to remain strong in 2016 as providers continue to partner in an effort to achieve scale, especially in response to the market transition to value-based care. Federal and payer challenges to hospital asset mergers and even virtual mergers will force many health systems to revisit vertical (payer and medical group) integration as an alternative foundation of their strategy, he says.

"One place we might see quick changes in response to reduced profits and reduced revenues is in the pediatrics space. Downward financial pressure means community hospitals will face the closure of their NICUs and smaller pediatric programs, and children's hospitals will step in to either manage these units or create new capacity on their own campuses," Hoffman says. "Simultaneously, integrated health systems holding on to their pediatric platforms will look to freestanding children's and academic medical centers for subspecialty support."

Partnerships across key pediatric programs, and across state lines, will broaden research populations, and further advances in pediatric research will require a push for even greater collaboration in the future, Hoffman predicts.

Sandefur says the healthcare players that come out ahead will be the ones that effectively manage both the top line and the bottom line. Managing the expense side of the equation will be just as important as working to bring in more revenue, he says.

"It will be critical to know the costs to treat your patients, knowing the cost of service lines, the cost to compete in the market," Sandefur says. "That's why we're seeing heavy investment in predictive analytics, business intelligence, and the data around population health management. It allows the better health systems to make smarter decisions."