Health care systems feeling the real financial effects of COVID-19

April 1, 2020

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Craig Standen

Craig Standen

The ongoing COVID-19 crisis will stretch the capacity and capabilities of the U.S. health care system to its limits. As cases continue to grow across the country, hospitals and systems engaged in this battle are also facing significant financial and operational challenges, the remedies for which are not yet known. Craig Standen, senior health care investment consultant on the nonprofit and advisory teams in Vanguard Institutional Investor Group, discusses those financial challenges in order to provide additional perspective for senior decision-makers at hospitals and health systems and suggest potential next steps.

What are the financial implications of the coronavirus for hospitals?

Mr. Standen: Over the past several weeks, in response to the emerging pressures on the U.S. health system, and nonprofit health care providers in particular, Standard & Poor's, Moody's Investors Service, and Fitch Ratings have all lowered their outlooks for the nonprofit health care sector to negative from stable. This is a little over two months after each agency issued stable outlooks on the sector driven by improving financial and operational fundamentals. The reason: The financial implications of this crisis are substantial and will materially impact the financial performance of the sector. All of the rating agencies—S&P, Moody's, and Fitch—have published commentary highlighting their views on the financial pressures that health care providers are facing related to the COVID-19 crisis.

The rapid rise in the number of cases led many hospitals to cancel or postpone elective and other noncritical-care surgeries in order to increase available capacity as med-surg beds were repurposed for critical and intensive care use. This action has, and will continue to have, a significant impact on revenues, as higher-margin elective surgeries make big contributions to overall profitability.

As the crisis rapidly unfolded, the lack of billing codes for COVID-19-related procedures and treatment led to major uncertainty regarding hospital reimbursement for treating COVID-19 patients, many of whom will require resource-intensive, and expensive, intensive care. To reduce financial uncertainty, many insurers have agreed to waive co-pays and cost-sharing for COVID-19 testing, and billing codes have recently been created to reimburse hospitals and other providers for COVID-19 treatment.

From an expense perspective, health care organizations are facing a barrage of unbudgeted, high-dollar expenditures for critical supplies and equipment, pharmaceuticals, and other lifesaving drugs, and significantly higher staffing costs related to increased overtime pay and costs of temporary clinical staff, as regular staff become infected with COVID-19. The increased expenditures are largely driven by the need to replace rapidly dwindling supplies as hospitals struggle to obtain what they need.

Additionally, many nonprofit hospitals whose capital structures include variable-rate bonds may face significantly higher interest costs. Despite overall interest rates falling, credit spreads have widened as reflected in indices such as the Securities Industry and Financial Markets Association Municipal Swap Index (SIFMA Index), which reflects interest rates on various types of variable-rate debt issued by nonprofit health care providers. The marked increase in the SIFMA Index in the past week is significant and reminiscent of the early days of the global financial crisis. Should these high levels persist for an extended period of time, interest expense for many providers will remain elevated and hurt profitability.

What effect have declines in the stock market had on hospital finances?

Mr. Standen: From an asset perspective, the significant decline in equity markets over the past several weeks and the marked increase in volatility have impacted health care providers in a number of ways.

The market value of their investments has declined dramatically. Nonprofit providers with outstanding debt likely have financial covenants that they are required to adhere to, and that are tested periodically (i.e., quarterly, semiannually, and/or annually). These covenants are typically tied to cash flow (i.e., debt service coverage), liquidity (days of unrestricted cash on hand), and/or leverage (debt as a percentage of total capital), and as is the case with many financing agreements, breaching a covenant threshold at a testing interval usually results in technical default. March 31 is the end of a calendar quarter and is a common testing interval for financial covenants.

Given the market downturn and the ongoing cash-flow pressures, a number of health care providers could face the possibility of violating one or more financial covenants, which would magnify the pressures on organizations that are focusing their efforts and resources on combating the COVID-19 outbreak.

What are the unknowns and their potential implications?

Mr. Standen: The primary unknown is how much worse the current crisis will become. At this stage, it's challenging to determine how long the crisis will last, and what the U.S. system of public health will look like when we reach the other side.

Near-term unknowns include:

  • Will health insurers, along with governments at all levels, continue to provide enhanced reimbursement and other funding support for the duration of the crisis to hospitals that treat COVID-19 patients?
  • Will we see emergency funding for hospital operations from state and local governments as well as from the federal government?
  • Absent additional funding support from the states and from the federal government, will hospitals be able to continue to treat patients?

Longer-term unknowns include:

  • Will we see an abatement in pressures (both from the government and private insurers) to reduce reimbursement rates?
  • Will the government take steps to support single-facility hospitals, particularly in rural areas? Will we see pressure to restrict hospital system mergers? Will the government work with nonprofit hospitals to create standby capacity for future public health emergencies?
  • We will likely see a discussion about who bears the brunt of costs for public health emergencies: Is it taxpayers broadly or hospitals narrowly?
  • Will nonprofit hospitals, which are likely to emerge as the heroes of this crisis, be better positioned to be successful at raising funds in the future?

What are the next steps for hospitals?

Mr. Standen: First and foremost, continue to do all you can for the patients in your hospitals and for your broader community. Health care workers and leaders are the heroes in this fight—across the country and the globe, we have seen them step up and deliver essential care amidst incredibly challenging circumstances.

Operations must be the primary near-term focus for hospitals and health care systems—we recommend your organization consider evolving financial implications in order to ensure care delivery over the long term.

  • Maintain contact with the investment advisory firm that oversees the investment assets of the hospital or the system to ensure you have a firm grasp on organizational liquidity. The portfolio value has likely taken a big hit and relative asset-class weighting has moved away from policy targets. If that's the case, have a clear understanding of the financial implications of rebalancing the portfolio.
  • Reach out to your external credit counterparties, including bankers, institutional investors, swap counterparties, and your bond/master trustee. Your bankers can help you identify and access sources of short-term funding if you are currently experiencing cash-flow challenges (or expect to in the future). If you are concerned about meeting your financial covenants at the next testing interval, it would be prudent to have those discussions up front with the relevant counterparties and evaluate the potential for compliance waivers.

As health care providers working on the front lines to preserve our health and safety, you have shouldered the burden of this crisis with remarkable dedication to your mission. In addition to the above recommendations, we offer our gratitude, support, and partnership during this unprecedented and challenging time.

Craig Standen serves as senior health care investment consultant on the nonprofit and advisory teams in Vanguard Institutional Investor Group. In this role, Mr. Standen is responsible for delivering Vanguard's comprehensive investment management solution to health care and nonprofit organizations, which integrates multiple asset pools with corporate finances and generates holistic/coordinated investment strategies designed to support organizational goals and objectives.


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