Morgan Stanley Report Shows 8% of Hospitals at Risk of Closure

AMONG THE ROUGHLY 6,500 HOSPITALS OPERATING in the United States, only about 125 (2.5%) have closed in the past five years. But in the coming years, some 450 hospitals are at risk of closing. Analysts at Morgan Stanley said 600 other hospitals have weak finances that could lead them to close.

In the report, Morgan Stanley, an investment bank and financial services company in New York, reviewed the financial strengths of about 6,500 U.S. hospitals and ranked 8% (450) as being at risk of potential closure and 10% (600) as being weak financially. Morgan Stanley rated the remaining 4,950 hospitals as being healthy financially.

For hospitals, much of the news in recent years has centered on mergers and acquisitions. M&A activity is slowing, however, and will give way to news about closures, the report said.

“We think hospital closures will increasingly drive the debate on healthcare disruption,” the report said. “After the Affordable Care Act of 2010, hospitals saw improved finances, and merger activity shot up for several years. But hospital profitability has been trending downward recently as management teams learn that bigger isn’t necessarily better.”

In addition, there are fewer buyers for single-facility hospitals because many health systems are focusing on integration from recent mergers, the report said, adding, “While potential disruption from the new Amazon venture has been grabbing headlines, we think closures will enter the narrative on hospitals during the next 12 to 18 months.”

Morgan Stanley’s report, Hospital X-Ray: Fractured Foot(print), used public data sources to assess the financial health of individual hospitals and explain why the number of hospitals that close will rise. Although the report was prepared to help investors, its conclusions are nonetheless revealing about the level of disruption that managers and pathologists in hospital labs may face in the coming months.

Hospital Finances

Morgan Stanley’s report is similar to one that Alvarez & Marsal, LLC, a restructuring and consulting firm in New York, produced in 2008. For that report, A&M studied the financial operations of 3,861 of the 4,900 acute-care hospitals operating in the United States. Among those 3,861 hospitals studied, 2,044 (53%) were not making a profit on patient care. (See TDR, May 27, 2008.)

As THE DARK REPORT noted at the time, the A&M report, Hospital Insolvency: The Looming Crises, showed the hospital industry was due to change dramatically and such a shift could affect the clinical laboratory and anatomic pathology professions. Since publication of the A&M report, hospitals have continued to struggle financially.

For its report, Morgan Stanley divided all hospitals into three groups: healthy, weak, or at risk. “Our analysis distinguishes healthy hospitals from weak ones, and goes further to break down the weak hospitals into a smaller subset of facilities that could potentially be at risk of closure or downsizing,” the report said. “We estimate 10% of hospitals in the US are weak and 8% could be at risk of closure.”

Morgan Stanley showed that nonprofit hospitals are in better shape than for-profit hospitals and that hospitals in the 32 states that expanded their Medicaid programs under the Affordable Care Act are stronger than hospitals in non-expansion states.

In the market for healthcare services, several factors are squeezing hospital profits, including competition from alternative sites of care, Morgan Stanley reported. As health insurers acquire out-patient facilities and physician networks, payers can drive members away from high-cost hospitals to lower-cost urgent care and ambulatory surgical centers and to freestanding emergency rooms, the report said.

The growing prevalence of high-deductible health plans reduces hospital revenue and increases bad debt when patients cannot afford to pay for care. For hospitals, more outpatient revenue and an increasing senior population will mean more government reimbursement at lower margins, the report said.

The Case Mix Factor

Other factors that determine a hospital’s financial strength are the case-mix among patients (because sicker patients require more resources and thus their care generates more revenue); bed capacity, characteristics of the market for healthcare services, cash flow, and level of government reimbursement.

Among for-profit hospitals in cities and towns with low healthcare utilization, profit margins become crucial, the Morgan Stanley analysts reported, adding, “under-performing facilities that drag down systemwide margins become targets for divestitures or, in extreme cases, closures for the publicly-traded, for-profit names.” When all other factors are equal, there is higher risk of closure among for-profit hospitals relative to nonprofit facilities, the Morgan Stanley analysts reported.

Among the for-profit hospital companies cited in the report were Tenet Healthcare (THC), Community Health (CYH), and Quorum Health Corp. (QHC), all of which have high debt levels, the report said. Those with high debt levels have the “time pressure of dealing with weak and at-risk facilities.” These for-profit companies are interested in divesting facilities to improve margins and reduce debt, but, “a recent slowdown in the pace of announced divestitures, coupled with reported closures, are a sign that the market for low-margin facilities is getting smaller,” the analysts explained.

Under-Performing Hospitals

Although prospects for nonprofit hospitals were less grim, the report suggested that those who invest in nonprofit hospitals should be wary. “Better balance sheets don’t make them immune from operating challenges, and our work shows that even the highest-rated systems have plenty of underperforming hospitals,” the report said.

As Morgan Stanley noted, cash flow is a significant factor that determines a hospital’s financial health. Ten years ago, Alvarez & Marsal also noted the importance of cash flow, reporting that 744 hospitals in its study earned so little that they could not fund day-to-day operations, make needed repairs, or support basic capital expenditures. In addition, A&M reported, access to sufficient numbers of patients was a big reason so many hospitals were failing to generate adequate revenue.

At the time, TDR wrote, “For many hospital-based laboratory managers and pathologists, A&M’s conclusions are not good news.” The same could be said of the Morgan Stanley report. As the A&M report said, “A ‘flight to (perceived) quality’ is occurring by both physicians and patients—creating a bigger gap between the fiscally strong and fiscally weak hospitals in a given market.”


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