How Do Hospitals Pay the Bills?

Jun 25, 2020

Most of you reading this today will work in a hospital at some point in your life if you have not already. Individuals join the medical workforce for a number of reasons including but not limited to inspiration from role models, a desire to help others, personal experiences at a hospital and like any other job, to make money. Healthcare workers perform a noble duty and deserve to earn a high-level of compensation, but how is this covered by hospitals? Aren’t all hospitals not-for-profit? Let’s take a closer look at how hospitals are run from a business standpoint.

Some of you may be thinking, well it is simple: the hospital sells services, the patient or insurance company pays for these services and the hospital covers their expenses. In theory, yes this is true. However, hospitals and health insurance are considered to be two of the most complex businesses with a vast array of services, payor models and operating expenses. There are over 6,000 hospitals with over 900,000 staffed beds in the United States as of 2018(1). Of those 6,000 hospitals, 2,937 are non-government not-for-profit, 1,296 are investor-owned for-profit, 965 are state and local government community hospitals, 209 federal government hospitals and the remainder are split amongst a number of specialty hospitals. We are going to take a closer look at not-for-profit and for-profit business models.

In simplest terms, a business has revenue (or sales) and expenses (or costs) and the revenue needs to meet or exceed the expenses in order for the business to stay open. Hospitals have hundreds or thousands of items that fall into these buckets, but let’s take a look at the main categories in both.

Largest revenue generators:

  • Short-term hospitalization
  • Emergency room services
  • Primary care services
  • General and specialty surgical services
  • X-ray and radiology
  • Laboratory services
  • Blood services

Largest expenses:

  • Labor and benefits
  • Research and development
  • Professional fees
  • Liability insurance
  • Equipment and supplies
  • Utilities
  • Mortgage or rent

The expense portion of these businesses is the most straightforward piece. As in any other business, you need to employ professionals to deliver your products or services. On average in 2016, labor represented 56% of hospitals’ annual expenses(2). Research and development can vary widely from hospital-to-hospital. R&D is the best way for hospitals to deliver the highest quality treatment and maintain their grants from the government and other funds. Professional fees include outsourced services such as legal representation, accounting, and tax services. Professional fees represent on average 12% of expenses(2), second to wages and benefits, which may seem high at first until you think of all of the litigation, legal negotiation and complex accounting involved with healthcare services. Equipment, supplies, utilities, and rent are the other major categories that keep the lights on at the hospital (literally!). Now that we have covered the easy part, here is the more complex piece – revenue.

One would think that revenue is simple, right? Not so much. There are a number of nuances when it comes to who is technically paying for services and what services or treatment are “needed”. There are over 1,300 insurance providers that hospitals do business with, many of which have their own unique plan. As of 2017, private health insurance was the predominant form of insurance for 67% of U.S. citizens and the remaining population is insured by Medicare and Medicaid, which are funded by the Federal Government. Private insurance and self-pay represent 68% of hospital’s revenue on average and the remainder is attributable to Medicare and Medicaid. However, it is worth noting that 64% of hospitals lose money on services paid for by Medicare(3), which means that private insurance and self-pay revenue covers an outsized proportion of a hospital’s expenses. Why is this?

  1. The type of service performed.
    • Individuals that are covered by private insurance are more likely to have elective surgeries and services performed on them. These services are profitable, money-making procedures for a hospital. Whereas, Medicare may primarily be covering services that break-even or lose a hospital money.
  2. The level of negotiation.
    • Private insurance companies negotiate deep discounts to services rendered by hospitals, which in turn leaves hospitals less profitable.
    • Medicare and Medicaid often pay hospitals less than the cost of programs.
  3. Demographic trends and advancement in technology.
    • The Medicare enrollment of Baby Boomers will increase 3% annually until 2029 and 2.4% for the decade after that(4). The result of this trend will be 82 million individuals on Medicare by 2030 compared to 55 million today.
    • As hospitals adopt new technology, it allows them to perform procedures that were historically inpatient in outpatient settings now. The result of this will be a reduction in the proportion of surgical patients and increase in non-surgical patients. Surgical treatment is typically a high margin service for hospitals.

How are insurers and the government able to pay hospitals less than they are charging? Because they represent such a large share of the hospital’s revenue, which leaves these payors with negotiating power. If the hospitals' customer base was more fragmented, then these payors would have less leverage over hospitals.

There are a number of factors that dictate how much of your bill your insurance will cover: in-patient vs. out-patient, in-network vs. out-network, elective vs. non-elective and many others. A major sticking point with insurers is the level of care you receive. For example, if you are recovering from a surgery and the doctor recommends you stay in the hospital for 10 days, the insurer could argue that this is too much time because other patients in their network have recovered from this surgery in less than 7 days. This topic has come to the point where hospitals and insurance companies are in constant debate and negotiation of prices and bills for patient care.

Lastly, what is the difference between not-for-profit and for-profit hospitals? Funding and tax liabilities. Not-for-profit hospitals are mainly funded by government funds, research funds, educational funds and charity. Because they are providing services in a not-for-profit manner for the community, the government does not require these hospitals to pay federal income, state and local property taxes. For-profit hospitals are funded by investors and research funds. So are hospitals profitable? A survey in 2016 found that 15-16% of both for-profit and not-for-profit hospitals have a negative operating margin(5), which means they lost money from their day-to-day business. Some hospitals are able to make up for this through investment income, charity and grants. Hospitals have averaged profit margins of 4-6% since 1981(6), which shows how close to the line hospitals operate.

We would like to note that this blog only scratches the surface of how a hospital runs as a business. If you are interested in the intricacies of health insurance, reimbursement and rate negotiation, there are number of articles and studies written on this subject that can be found via a Google search.

Interested in more financial topics? Comment below.

Sources

  1. https://www.aha.org/statistics/fast-facts-us-hospitals
  2. https://www.statista.com/statistics/204985/percent-of-hospital-costs-by-type-of-expense/#:~:text=The%20greatest%20expense%20of%20hospitals,percent%20of%20all%20hospital%20expenses.
  3. Avalere Health analysis of American Hospital Association Annual Survey data, 2015 for community hospitals.
  4. https://hbr.org/2017/11/5-ways-u-s-hospitals-can-respond-to-medicares-mounting-costs
  5. http://www.healthleadersmedia.com/finance/differences-between-nfps-and-profits-are-marginal
  6. https://truecostofhealthcare.org/aha-records/
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