Are Hospital Systems Losing Their Mojo?

Sometimes big game hunters find frustration when their prey moves by the time they’ve lined up to blast it. That certainly appears to be the case with the health policy target de jour: whether providers, hospital systems in particular, exert too much market power. 

Hospitals’ market power appears to be one of those frustrating moving targets. The past 18 months have seen a spate of hospital industry layoffs by market-leading institutions, and also a string of terrible earnings releases from some of the most powerful hospital systems and “integrated delivery networks” in the country. 

One system everyone points to as a poster child for excessive market power: California-based Sutter Health. Sutter lost $22 million on operations in FY13 (ended in December), — compared to a gain of $697 million in FY11 — on more than $9.6 billion in revenues.  A 3% decline in admissions led to FY13 revenue growth of 0.9% (that is, nine-tenths of one percent), against 7.3% in expense growth.

These results were not atypical. After Sutter, the second most powerful health system in the West, Seattle-based Providence Health and Services, had $37.7 million in operating earnings in FY13 — compared to $239 million in 2011 — on $11 billion in revenues and essentially flat admissions.

What I think these earnings reports mean is that these large systems have been unable to offset declines in utilization and Medicare funding reductions by cost shifting to private insurers. According to the Bureau of Labor Statistics, overall hospital pricing growth has gradually declined for a decade into the low single digits. 

I think the soft rate controls contained in the ACA, including the de facto 10% cap on health insurance rate increases imposed by CMS, and the threatened exclusion of plans that raise their rates by more than the cap from the ACA’s Exchanges, may have toughened the rate negotiating posture of health plans with their hospital networks. A number of large national health plans missed their earnings targets in the 4th Quarter of 2013, according to CitiGroup’s health insurance analyst, Carl McDonald. These earnings misses will undoubtedly result in continued pressure on rate negotiations between hospitals and insurers. 

If one looked at FY11 operating results for the health systems above, one would have drawn a completely different conclusion about the effects of industry consolidation, as many large health systems generated record operating earnings in that year. Did their leverage completely disappear in the succeeding two years?  Probably not. Higher contracted price increases to the large regional hospital systems may have been “financed” by minimal or non-existent increases to the marginal hospital players. But it does appear that double-digit rate increases for big hospital systems are gone.

I believe that the negotiating climate between systems and health plans has actually materially toughened. A more plausible explanation for some big systems’ mediocre operating results is that a few really good years led to laxity on the cost control side, requiring health system managers to refocus on efficiency and quality.  The only way to know for sure is to be patient and let the market reveal itself to us.

The policy challenges created by disinflation are different than those required by hyperinflation. Multiple years of aggressive rate increases by large systems has likely left behind very significant pricing gaps between large and small players in many markets.

This means that reference pricing strategies that reward consumers for selecting high value providers for certain procedures (imaging, arthroscopy, cardiac care, etc.) –  could have a major effect of shifting volume to more efficient, or less aggressively priced, smaller players, including physician sponsored surgical and imaging providers.

Health insurers and employers will certainly need to keep the pressure on their provider networks. But it is clear that the most reliable source of future earnings for these powerful health systems will be in squeezing waste out of their staffing and care processes, and actually finding the elusive “economies of scale” the consultants and bankers have talked about for the past 30 years. But creating measurable value for the ultimate customer of health care, patients, and their families, is the most reliable and defensible source of future earnings growth. 

Jeff Goldsmith is president of Health Futures Inc.. A version of this article originally appeared on The Health Care Blog.