Did Maryland’s Unique Hospital Rate Setting System Outperform the US During the Pandemic?
Maryland hospitals’ financial performance in 2020 was very comparable to the rest of the U.S., as compared with Moody’s Investors Service’s preliminary 2020 medians for nonprofit hospitals. Hospitals across the country, including in Maryland, faced significant operating headwinds resulting primarily from COVID-19, on top of pre-existing industry pressures. Maryland hospitals’ median operating margin in 2020 was just 0.5%, exactly the same as Moody’s reported nationally in their preliminary 2020 medians. This was down from an already meager 1.9% in Maryland for 2019 and 2.4% in Moody’s national sample. While weaker operating results are not surprising given the combination of revenue and expense pressures experienced during the early months of the pandemic, we had expected Maryland hospitals to fare somewhat better than hospitals elsewhere during COVID-19 due to its unique reimbursement system that provides hospitals a revenue cushion against declining volumes. There are several potential reasons for the lack of outperformance in Maryland, including the outsized impact of federal aid, especially the CARES Act.
Maryland Hospitals Were Expected to Outperform U.S.
Early in last year’s pandemic-related shutdowns, U.S. hospitals were facing the perfect storm of fiscal pressure due to the coronavirus pandemic, including sharply lower revenues, growing expenses for supplies, protective equipment, and staff, and a lower stock market stressing hospitals’ liquidity cushion. For the many U.S. hospitals that were already operating on thin margins or had little in cash reserves, the COVID-19 crisis could have quickly become an existential one without sizable and immediate help. These pressures came on top of what was already a challenging environment for hospitals, causing all three major rating agencies to change their outlooks on the nonprofit healthcare sector to negative.
Against that backdrop, we expected Maryland hospitals to be cushioned somewhat by its unique “Total Cost of Care” model, which features a Global Budget Revenue for each hospital, providing hospitals a revenue cushion against declining volumes. With hospitals cancelling elective and nonemergency procedures and visits to preserve capacity for an expected surge in COVID-19 cases, hospital volumes fell dramatically in spring 2020 across the country, often exceeding 20% and frequently without a commensurate increase in COVID-related volume. Furthermore, COVID volumes were generally less profitable than the elective volumes they replaced. For most hospitals outside of Maryland, the combination of declining volume and rising expenses is disastrous. But in Maryland, while expense pressures were like those around the country, we expected the state’s reimbursement system to cushion revenue declines somewhat.
To simplify what is in reality a very complex system, each hospital’s total annual revenue is known at the beginning of each fiscal year. As hospitals provide services to patients, they charge an amount designed to achieve the total global budget revenue amount by year-end. When patient volumes decline, the hospitals actually charge more per unit of service, and when volumes rise, they charge less, within limits, or “corridors” set by the state. All this is designed to give hospitals an incentive to manage the total cost of care for patients and avoid some of the perverse incentives of the fee-for-service system common elsewhere in the U.S., where hospitals are generally paid for each visit, procedure, or stay, and are thus incentivized to do more. In the pandemic, the Maryland system was expected to provide some downside protection to hospitals from lost volumes. The state temporarily widened its corridors to allow hospitals to recoup a greater portion of their Global Budget Revenue for 2020 than would otherwise be the case, but many Maryland hospitals’ volumes declined more than the increased corridor allowed for, resulting in revenues that fell short of the Global Budget Revenue by an average of 5%, according to Maryland’s Health Services Cost Review Commission, which sets the global revenue budgets.
Financial Results in Line with U.S.
Maryland hospitals’ financial performance in 2020 was strikingly like the rest of the U.S., as compared with Moody’s Investors Service’s preliminary medians, which they based on results for 130 nonprofit hospitals and health systems with primarily June 30th fiscal year-ends, the same fiscal year-end that Maryland hospitals use. Our sample uses 13 Maryland hospitals and healthcare systems, several which are rated by Moody’s. Moody’s reported that operating margin nationally fell to just 0.5% in 2020 from 2.4% in 2019, prompting industry observers to declare the weak margins “wholly unsustainable”. Maryland hospitals’ median operating margin in 2020 was same as Moody’s at 0.5%, down from an anemic 1.9% the prior year. Similarly, Moody’s reported that operating cash flow margin fell nationally to 6.7% in 2020 from 8.4%. Maryland hospitals’ operating cash flow margin fell a little bit more than Moody’s benchmark, to 6.9% in 2020 from 8.9%. However, operating performance wasn’t universally weaker for all Maryland hospitals. Of the 13 hospitals and healthcare systems in our sample, operating margin and operating cash flow margin rose for 4 of them, bucking the overall trend.
Liquidity was a bright spot, bolstered by advances from Medicare. Moody’s median days’ cash on hand rose significantly, by 21% to 250 days, while our sample of Maryland hospitals showed a somewhat smaller increase of 12%, to 261 days. Just 2 of the 13 Maryland hospitals saw their days’ cash decrease, one of which did not accept Medicare advances, and the other due to dilution from a merger. However, without the Medicare advances, which started to be repaid in April 2021, median days’ cash in Maryland rose a modest 3% to 241. Other contributors to days’ cash growth are capital spending reductions, CARES Act funding, line of credit draws, and payroll tax deferrals.
It’s unclear why Maryland hospitals didn’t appear to benefit from the rate setting system’s built-in downside cushion in fiscal 2020. If ever there was a circumstance when the state’s rate setting mechanism would be particularly beneficial, it should have been 2020. Likely the biggest contributing factor is the outsized impact of federal support swamped the size of Maryland’s rate setting cushion. In other words, Maryland’s system did provide a cushion, it was just a lot smaller than federal fiscal support. Other contributors to Maryland’s lack of outperformance compared to the U.S. could be the small sample size of 13 health systems in Maryland being more susceptible to unique circumstances at just a couple of entities, the fact that the rate setting system only regulates hospital revenue, while healthcare systems routinely have other nonregulated business lines such as physician practices, the ownership of non-Maryland hospitals by a few healthcare systems headquartered in the state, and the timing and scale of business interruption in Maryland compared to elsewhere.
Substantial Federal Support for Operations and Liquidity
Maryland hospitals, like most in the U.S., had access to several federal support mechanisms for operations and liquidity to offset the effects of COVID. As with other measures, Maryland hospitals’ reliance on those support mechanisms appear to track very closely with the rest of the country.
All Maryland hospitals in our sample received CARES Act funding (aka “Provider Relief Funds”), accounting for 1.8%-8.7% of operating revenue, with a median 2.7%. These revenues accounted for a sizable 43% of operating cash flow for Maryland hospitals, exactly the same as Moody’s national sample. The range of CARES Act revenue as a percent of operating cash flow was 14%-100% in Moody’s report, and 22% to over 100% in Maryland, indicating that reliance on CARES Act revenue was at least as high in Maryland as elsewhere.
Operating support from CARES Act funding continues in fiscal 2021. Almost all Maryland hospitals in our sample reported receiving additional provider relief funds after the close of fiscal 2020, to be applied to fiscal 2021 revenue if eligibility requirements are met. These amounts received after the close of the fiscal year were in general almost as great as in fiscal 2020.
The Centers for Medicare and Medicaid Services (CMS) Accelerated and Advanced Payment Program provided working capital advances against Medicare claims, accounting for the bulk of the increased days’ cash on hand. The amounts were significant as a percent of unrestricted cash reserves, ranging from 15% to 50% in Maryland, with a median of 20%. Eleven of the 13 Maryland hospitals accepted the advances. Because the advances are being “repaid” since April 2021 as offsets to claims that hospitals file with Medicare for patient services, we expect much of the recent big boost in days’ cash to be temporary.
Payroll Tax Deferrals
The CARES Act allowed for deferred payment of the employer portion of social security taxes, with half of the deferred amount due Dec. 31, 2021 and the other half Dec. 31, 2022. Similar to Medicare advances, the deferral boosts working capital but does not enhance income and because it must be repaid, the liquidity boost will be temporary. Only 5 of the 13 hospitals in our Maryland sample elected the deferral, accounting for less than 1% of fiscal year-end unrestricted cash reserves.
Paycheck Protection Program
Established under the CARES Act, the Paycheck Protection Program (PPP) provides forgivable loans if certain conditions are met. Of the major federal relief programs, PPP was the least used by Maryland hospitals, likely because the program is targeted to small businesses. Only one Maryland hospital reported a PPP loan in fiscal 2020, accounting for a very small 0.25% of operating revenue. Although small, the loan directly improved the hospital’s bottom line because the conditions for forgiveness were met, allowing the loan to be recorded as a reduction in salary expense.
Strong Rebound in 2021
Hospital financial performance is rebounding strongly so far this year. We reviewed financial filings for 10 Maryland hospitals and health systems in our sample who reported results for the nine months ended March 31, 2021. With just three months remaining in the fiscal year, operating margin and operating cash flow margin are significantly better this year at a median 3.3% and 9.6%, respectively. Cash balances remain very strong, as Medicare advances are still on the balance sheet as of March 31st. Comparative rating agency medians for fiscal 2021 won’t be available until next year, but it’s likely that the rebound in performance was widespread. We attribute the improvement to continued support from provider relief funds, hospitals learning to manage both COVID and non-COVID volumes simultaneously, easing of the most acute equipment shortages, and pent-up demand from consumers who delayed medical care last year.
Will it Last?
Once COVID-19 fades, federal stimulus money runs out, and Medicare advances are repaid, will the current stronger performance continue? We expect lingering challenges from the pandemic including managing the mix of COVID and non-COVID volumes, supply expenses, and growing staffing shortages. These challenges are on top of pre-existing stresses in the industry including growing expenses for pharmaceuticals, shift to outpatient services from inpatient, investments in technology and integrated care delivery, and worsening payor mixes. Additionally, new challenges are emerging such as the impact of growing consumer demand for telemedicine, which can shift the competitive landscape in unexpected ways. Maryland hospitals are shielded from some of these pressures, including negative payor mix shifts and to some extent volume declines, but as we saw in 2020, they are subject to most of the same macro trends as hospitals elsewhere in the U.S.
The author is President of Nutshell Associates LLC, a municipal advisory and public finance consulting firm, and a board member of the University of Maryland Medical System (UMMS), one of the largest healthcare systems in the mid-Atlantic. UMMS’ hospitals operate under global budget revenue agreements and UMMS has debt outstanding in the municipal debt market. UMMS is one of the 13 Maryland hospitals and health systems in this study.