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1 Link: San Diego hospital systems have reported significant drops in operating income given a whirlwind of financial pressures. Faced with growing expenses and reimbursement struggles, hospitals have pursued cost-cutting measures, reorganized, sought scale and even announced layoffs. Far from insolvency, the region s hospital systems are largely bringing in more than they spend, have strong reserves, and a roaring stock market mostly bolstered net incomes, according to data compiled by the San Diego Business Journal. But experts and hospital representatives say the systems can t rely long term on stock market investment income to mask tumbling operating income the measure of revenue minus expenses. We re at a point in the industry where the expense trends are outpacing the revenue trends and that s just not sustainable, said James Bush, a principal with Deloitte Consulting s health care and life sciences consulting practice.

2 Hospitals already thin operating margins on average 4.9 percent nationally from 2008 to 2014 are forecasted to plummet absent significant organizational changes. A typical $2 billion health system with a 5 percent operating margin today that does nothing will see that figure drop to negative 4 percent by 2020, according to an analysis from Deloitte actuaries. Reimbursement Issues Reimbursement issues, including an increase in Medicare and Medicaid patients and less money from those programs, plague hospital systems. Most organizations struggle to make money on Medicare, and very few if any make money on Medicaid patients, Bush said. In addition, health systems felt the squeeze of rising costs for facilities, supplies, medicines and staff salaries alone generally eat up 60 percent of an operating budget. Nursing salaries specifically have gotten very competitive as organizations try to retain a good, experienced workforce, said Sharp HealthCare CFO Staci Dickerson. An agreement between Sharp Health and the nurses union in late 2016 increased pay 8 percent to 12 percent in the first 12 months of the three-year deal, according to the nurses union, among a round of recent regional contracts that upped pay. Amid increases in salary and benefits and flat patient volumes, Sharp reported operating income of $151.1 million in fiscal year 2017, down nearly 50 percent from the previous year. Yet another factor was a $28 million year-over-year drop in a Medi-Cal provider fee, due in part to volatility in Sharp receiving money owed. Despite this, Standard & Poor s in December upgraded Sharp s rating on outstanding debt from AA- to AA, citing a still strong balance sheet and growing market share. But it did point out softer fiscal performance in To reverse this trajectory, Dickerson said it s imperative to reduce costs, though layoffs aren t on the table. She gave the example of shopping around for better deals on service provider contracts. It s not just a one-time look at reducing our expenses. We know this. We ve seen this is coming. Each and every day, it s how can we operate in the most cost effective manner possible while still providing the highest quality care? Dickerson said. Costs of New Facility

3 UC San Diego Health s operating income in fiscal year 2017 was $19.7 million, a steep drop from $147.3 million two years prior. Executives largely chalked this up to increased expenses ahead of the November 2016 opening of Jacobs Medical Center. It had to hire and train employees, and took on higher depreciation and interest costs. With hospital beds now occupied there, that should help the balance sheet. The facility is full now and so the future is looking much better as we look forward. But we did have some one-time costs related to opening up, said Lori Donaldson, CFO of UC San Diego Health. Even with Jacobs built, long-term plans call for a major revamp of its Hillcrest medical campus, prompted by regulations that require hospital earthquake proofing by We re relatively bullish on our three to five year forecast. But we re managing cash really tightly right now, because we have to, given the new facilities, said CEO Patty Maysent. Aside from facilities, UC San Diego Health took a hit in the last two years from increased salary and pension costs, a reality for many employers with the tight labor market. It wants to address expenses in a number of ways. That includes an expanded footprint with the dual aim of new revenue sources and cost-savings scale, increasingly sharing services across sites, and not layoffs, but growing the workforce at a slower pace. In addition, it has turned to alternative reimbursement models. Last month, UC San Diego Health launched a Medicare Accountable Care Organization, which brings the potential for savings, but only if it can meet care and cost benchmarks. Multipronged Recovery Strategy Unlike other hospital systems, Palomar Health s operating margins trended up in recent years, as it climbed out of a hole from building Palomar Medical Center Escondido. It posted a $15.5 million operating loss in fiscal year 2015, but recorded more than $6 million in operating income in 2016, and about the same income in Net income also significantly improved, yet it still posted a $17.7 million loss in this category last year.

4 The multipronged recovery strategy encompassed consolidation and new efficiencies in the district s revenue cycle. Further progress will come from the recent $18 million sale of the old downtown Escondido hospital, a deal slated to wrap up in 15 months. But it too faces reimbursement and expense issues. We had to make some changes that occurred in our past, and we have continued to move in directions to reduce our expenses, said Palomar Health CFO Hugh King. Notably, the district recently announced 42 layoffs, mostly executive level positions, as part of a reorganization. We basically took out one level of management...one of things we re trying to do is flatten the organization and get the leadership at a closer level to where services are delivered to patients, King said. Possible Staff Cuts Layoffs and a reorganization are also on tap at Scripps Health, according to a Dec. 22 San Diego Union-Tribune article. CEO Chris Van Gorder told the newspaper the organization must continue to bring in more revenue than it spends, even if the strong stock market conceals declining operating income. Scripps Health, which did not respond to requests to comment, reported $68.4 million in operating income in fiscal year 2017, compared to $142.8 million in the prior year and $143.5 million in Like others, Palomar foresees a migration of hospitals profitable imaging and surgery procedures to freestanding centers. The health district is exploring joint partnerships with such facilities to keep a piece of the revenue. Whatever we can do to provide treatment in a lower cost setting, where we can still generate some margin, King said. He added lower hospital admission rates pose an industrywide challenge. A Tri-City spokesman said CEO Steve Dietlin was not available for an interview. The health system saw $424,000 in operating income fiscal year 2015, followed by a $6 million loss in 2016 and a $1.5 million loss in Oakland-based Kaiser Permanente, which operates in eight states and has a San Diego presence, bucked the regional trend of expenses rising faster than revenue.

5 Its fiscal year 2017 operating income was $2.2 billion, versus $1.9 billion the previous year. Kaiser health plan membership for 2017 grew by about 1.1 million, including 650,000 from an acquisition, for a total of 11.8 million members. The hospital industry has faced financial obstacles before, but this is a new level of disruption. So said Bush with Deloitte Consulting. Hospitals, in response, are exploring new technology like robotic process automation, which hands off repetitive tasks to machines, said Bush. The urgency to change your strategy is becoming more and more important, because the pressure on the cost structure is increasing and their reimbursement structures are less and less.

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