CFO Magazine

Operating Room

Rising hospital costs, a plague to most companies, have helped some finance chiefs nurse profits back to health.

Andrew Osterland
CFO Magazine

January 1, 2002

The mid-1990s were promising years for most corporate finance chiefs trying to hold down health-care costs, but painful ones for hospital companies such as Tenet Healthcare. Like other hospital operators, Tenet was no match for the rapidly growing health maintenance organizations that were signing up cost-conscious employers by the thousands. Even in the Southern California market, where Tenet operated 12 facilities, it was in no position to argue with the HMOs during annual contract negotiations. If Tenet didn't agree to lower reimbursement rates, the HMOs would simply look elsewhere.

"We had to accept it," says David Dennis, who became Tenet's CFO in March 2000. "The managed-care companies were competing on price, and we had to share the pain."

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To the dismay of companies that pay health-insurance premiums — and the relief of health-care providers like Tenet — the balance of power has changed dramatically. While consumers were rebelling against restrictive managed-care plans, hospital companies were acquiring their way to lower cost structures and improved bargaining positions with insurers. Now the nation's second-largest investor-owned hospital chain, Tenet bought 18 more Southern California hospitals over the past five years, and today wields far greater leverage with the health plans. "The days when [HMOs] get 10 to 20 percent premium increases and capitate their costs with us are over," says Dennis.

This hardly comes as a surprise to most finance chiefs. It's one reason that commercial health-insurance premiums increased by an average of 10.2 percent in 2001, according to the Kaiser Family Foundation's annual survey of employer-sponsored health benefits. The largest increase since 1992, it follows an almost 8 percent rise in 2000. And early indications from this year's insurance renewals suggest that rate hikes will continue higher for 2002.

For health-care providers, the trend is most noticeable in markets with high levels of managed-care penetration, like Southern California. But it's felt everywhere in the United States to some degree. At the same time, the government side of the hospital operators' business has also improved, at least marginally. In 1999, Congress passed legislation to restore some $8 billion of the estimated $97 billion of cutbacks in Medicare reimbursements through 2004 resulting from the Balanced Budget Act of 1997.

"The pendulum has shifted in our favor over the last few years," says Burke Whitman, CFO of Dallas-based Triad Hospitals. The chain of 47 middle-market hospitals, spun off in 1999 by HCA Corp., posted third- quarter earnings of $6.5 million, compared with a net loss of $1 million in the prior year, and its stock has more than tripled since the spin-off. Earnings at other investor-owned hospital chains — including HCA, Tenet, and small-market and rural providers like Health Management Associates and Lifepoint Hospitals — have also done well, making hospital stocks a favorite haven for investors in this tumultuous market. Indeed, the Morgan Stanley Capital International USA Healthcare Providers Index was up 74 percent in 2000, and was flat through December 3 of last year.

The sharply improved financial outlook for health-care providers, however, is far from universal, especially among the large majority of U.S. hospitals that operate on a not-for-profit basis. While the number of investor-owned hospitals has been growing in recent years, more than 8 of every 10 institutions are still nonprofit. And many of these cater to the population's most vulnerable, and least profitable, patients.

Among the 4,800 hospitals registered with the American Hospital Association (AHA), one third earn a profit, while another third break even, and the remaining third operate in the red, says AHA senior vice president Rick Wade. For most health-care providers, "the bottom line is not the driving force," he says. "Their first mission is to do good works and to organize the limited resources they have to meet that mission."

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