Risks Loom As Hospitals Morph Their Business Model

October 2016

The world of healthcare looks dramatically different than it did two years ago. Three foundational shifts are taking shape under the new administration. At the same time, five revolutionary forces are picking up speed within the industry, unleashing a spate of innovative M&A activity. Read more about the new landscape—and how your organization’s business model could be impacted.

Changes in the way that doctors are reimbursed by Medicare will hasten a seminal transformation in the organization and delivery of medical care. Providers have been consolidating into large organizations. The overwhelming majority of these new arrangements are centered on a hospital. This trend is going to accelerate.
Under the legislation that’s come to be known as MACRA, more medium and larger medical practices -- that have, so far, withstood the economic and political pressures driving this trend -- are going to find that they, too, are subject to its forces.
A larger share of medical practices will find that they can’t take the economic risk that MACRA imposes, or comply with its costly reporting requirements.
They, too, will throw in the towel.
It begs the question whether hospitals are properly positioning themselves to take on these new business models. And whether they’re adapting to bear actuarial risk for providing medical care to large groups of patients, and to manage providers and the delivery of medical care across both the inpatient and outpatient settings.
Now, adding to these challenges, hospitals face a number of unique headwinds. They should be mindful to keep their eyes on these economic and political risks that could weigh on them, just as they’re trying to transform themselves to their new models.
A softening payor mix will erode reimbursements
First, hospitals are likely to face a worsening mix of payors in tandem with the consolidation, as the exchanges expand, and as health plans continue to hollow out their benefits. This recently prompted analysts at Citi to downgrade the hospital sector. As they noted, the market has fixated on the potential for slowing volume. But payor mix deterioration is perhaps a bigger burden, and it’s gone unnoticed.
As Citi noted, many hospitals bucket Medicare Advantage and managed Medicaid within the commercial segment, making it hard to see the softening mix. But even a stable commercial mix suggests deterioration given the faster growth within the Medicare Advantage and managed Medicaid segments, and a disproportionate contribution from the exchanges, which are being dominated by lower-cost carriers that reimburse hospitals at lower rates than traditional commercial plans.
The exchanges could also start to expand more quickly than forecasted.
More families who now have employer-sponsored insurance (ESI), but who fall below 250% of the Federal poverty level (about $45,000 annually for a family of four) are likely to shift onto the exchanges to take advantage of its rich cost-sharing subsidies. The combined subsidy that people in this income range get on the exchanges dwarfs the implicit subsidy they receive by being able to spend pre-tax dollars at work on their healthcare premiums. If more families with higher value ESI shift onto lower value exchange plans, it will reduce the value of the “average” benefit that people have, further eroding the mix that hospitals must grapple with.
Service reimbursement differentials may not be so different in future
Second, many of the political efforts to “reform” Obamacare aim to expand its subsidies. Depending on the outcome of the November election, these efforts will require new revenue, and that money is likely to come out of existing healthcare programs. High on the list of offsets are the site of service payment differentials between Medicare’s outpatient (Part B) and inpatient (Part A) insurance schemes.
For a lot of clinical procedures, the reimbursement rates for the same services are much higher when they’re billed under Part A. Some of these differentials, such as those for cardiology procedures, can be significant. Medicare’s advisory board has criticized site of service differentials, and there’s a bipartisan consensus in Congress that wants to sand them away. Yet this financial arbitrage between Medicare’s Part A and Part B billing schemes helped provide the economic rationalization for some of the provider consolidation, and offset the costs. Hospitals may soon have to contend with price schedules that cut the inpatient rates down to outpatient size.
The question is whether the acquisitions hospitals made of doctor practices will still be economically sound once these site-of-service payment rates are equilibrated.
Hospitals’ assets no longer match up with their business risks
Third, as hospitals continue to bear more actuarial risk, they’re going to look more and more like insurers. In fact, there’s a growing trend toward hospitals launching their own Exclusive Provider Organizations (EPOs) on the exchanges. But so far, regulations have not treated hospitals like insurers. That too could change.
Will hospitals be able to reserve the capital necessary to backstop their risk if they begin to bear the same regulatory burdens as traditional insurers? Much of their capital is locked up in physical infrastructure and not well aligned with their new business models that could require them to reserve money against their risk.
Similarly, as hospitals take on more risk for the post-acute portion of medical care as part of “bundles,” they’ll also have to deploy more capital for managing outpatient services in the community. Their capital is misaligned with these business goals.
Hospitals have transformed their business models over a very short period of time. Political trends will force them to bear more capitated risk for the post-acute delivery of medical care, and give them added incentives to consolidate providers.
But their economic structures haven’t changed in concert with these new arrangements. Hospitals need to catch up, and time is short. There’s a series of new policy risks that could impair these already stretched arrangements.