Thoughts from Ken Kaufman
Month in and month out, the Kaufman Hall National Hospital Flash Report monitors and reports on hospital performance indicators related to profitability, revenue, and expense, noting both month-to-month movement and broader trends.
This monthly practice puts Kaufman Hall in an excellent position, when concerning trends or potentially threatening external factors arise, to pause and look very closely at what the numbers tell us about the specific vulnerabilities of America’s hospitals.
A critical time for such an analysis is here.
Policy changes related to Medicaid, the Affordable Care Act (ACA), and site-neutral payment, among others, all threaten to undermine hospital revenue streams. At the same time, Flash Report findings show we may already be seeing the effects of some of these policy changes, particularly related to levels of bad debt and charity care and emergency department (ED) use.
Further, the numbers present a harsh truth: A historically large percentage of hospitals and health systems are operating at negative or very thin margins, making these organizations vulnerable to even modest reductions in revenue and far more vulnerable to the reductions likely to accompany the most sweeping and the hospital-unfriendly collection of health policies we have seen for quite some time.
With this impetus, I got together with Erik Swanson, managing director and Data and Analytics group leader at Kaufman Hall and author of the National Hospital Flash Report, to pick his brain about what the numbers show regarding the current health of hospitals and how trends in bad debt, charity care, and ED use may signal challenges to come. Erik and I also discussed what hospitals can do sooner rather than later to deal with the emerging and urgent performance pressures.
Probably the best word to describe the financial condition of hospitals is tenuous.
Before the pandemic, operating margins were barely sufficient for hospitals to make necessary investments in themselves. Now, post-pandemic, margins are worse. Year-to-date through August, hospital operating margins adjusted for corporate allocations are a very thin 2.5%, compared with 3% to 3.5% operating margins before the pandemic. For health systems, year-to-date operating margins are an even more troubling 1.8%. Although a small number of hospitals are doing well, about 44% of hospitals, and a similar number of health systems, have negative operating margins, compared with about one-third of hospitals losing money prior to the pandemic.
What makes the current situation particularly consequential is how sensitive those thin margins are to small changes in payer mix and other external pressures. A hospital or health system does not have to experience a massive change in its patient population or reimbursement to see its margin disappear.
For example, a 1% reduction in Medicaid volume that transitions to self-pay can affect the bottom line by approximately 30 basis points, or 0.3%. Given that health systems are operating at about a 1.8% median margin, a roughly 5% shift from Medicaid to self-pay could put that median margin at zero.
The shift from commercial insurance is even more consequential. A 1% reduction in commercial rates can account for approximately 113 basis points. In other words, a little more than a 1% reduction in commercial-insured patients could potentially eliminate all of the margin being produced at the median hospital.
That gives a sense of how razor-thin the margins are and how sensitive hospitals and systems are to relatively slight changes. Single-digit percentage changes can affect the bottom line by a significant order of magnitude.
Numerous current and emerging external pressures can affect margins. Payer mix is eroding broadly, with increases in governmental payers and decreases in commercial insurance, some of which are associated with the growth in Medicare Advantage. At the same time, hospitals and systems are dealing with pressures involving the Affordable Care Act, Medicaid, site neutrality, inflation, labor and other costs, and a broad range of other economic forces.
The industry needs to take these numbers and relationships seriously. A hospital that is currently making a positive margin cannot assume that its historical performance will protect it from what is coming. Some organizations that have been making very positive margins could, based on the relationships between payer changes and operating performance, find themselves at breakeven or in a loss position as early as the middle of 2027.
Uncompensated care, when charity care and bad debt are considered together, constitutes approximately 2.7% of total gross operating revenue. Extrapolated nationwide across annual hospital spending, that amounts to approximately $40 billion a year.
What is particularly concerning is that bad debt and charity care are taking up an increasingly large share of hospital revenue.
Year-to-date, uncompensated care as a percentage of revenue has grown approximately 6.8% year over year. There was approximately 7% growth the year before and roughly 15% growth over 2023, so growth has been significant over the last three years.
The two components are also beginning to tell an important story. Charity care and bad debt are fairly evenly split within the overall 2.5% of gross operating revenue. Charity care itself has grown approximately 4.3% as a percentage of gross revenue year over year, about twice the rate of growth from the prior year. That suggests that something is happening this year that is driving up the growth rate of charity care.
Bad debt has also grown year over year, although not to the same degree as charity care. We are, therefore, seeing some conversion of bad debt to charity care. More hospitals are identifying patients who need financial assistance, providing that assistance, and, in some instances, transitioning patients from bad debt to charity care.
That distinction matters because bad debt is inherently a lagging indicator. A hospital often does not know that an account is bad debt until 90 or 180 days have passed. Charity care is more of a leading indicator. A patient comes into the hospital, and the hospital identifies that the patient is underinsured, lacks the ability to pay, or is otherwise at significant financial risk. The hospital can immediately place that patient into financial assistance services. The growth in charity care can tell us something about what is happening now, whereas bad debt may not fully reflect current conditions for another 6 months.
That is particularly relevant to the challenges surrounding coverage. The expiration of the ACA enhanced advanced premium tax credits can lead to more people becoming underinsured or having difficulty paying their residual obligations. Even people who technically have insurance can have difficulty paying what they owe, and that difficulty can eventually appear as either bad debt or charity care.
The same concern applies to Medicaid changes. Community engagement requirements and other financing changes that could cause patients to lose coverage are expected to have an effect as those policies take hold. Those patients may subsequently appear in the bad debt and charity-care figures.
The broader point is that affordability challenges are becoming visible in the hospital financial data. The decline in overall contractual or collection rates relative to what hospitals expect is another indication of an eroding payer mix. More patients are struggling with the amount they are responsible for paying, and hospitals are absorbing more of that burden.
The concern is not simply that uncompensated care is increasing. It is that uncompensated care is increasing at a time when hospitals have very little margin for error.
The ACA provides an important historical example. Before the ACA took effect, uncompensated care was in the mid-teens as a percentage of net operating revenue, depending on the measure and period used. Following implementation of the ACA, it fell to roughly 8%. That reduction made an enormous difference to hospitals. Organizations that had been losing 2% or 3% found themselves at breakeven or making a small amount of money as uncompensated care declined.
Some hospitals are still in business because that change occurred. Now the trend is moving in the other direction. If uncompensated care rises from roughly 8% toward 10% and beyond, that creates a direct financial burden, and every percentage-point increase puts additional hospitals at risk.
ED utilization is another important indicator of what is happening to hospital populations and payer mix. In almost every state examined, ED visits have grown this year relative to prior years. The three-year trend is somewhat harder to interpret because of the lingering effects of the pandemic, but the general growth in ED utilization is substantial.
More importantly, the composition of the patients coming through the ED has changed. There are greater levels of uninsured and underinsured patients, including people who are using the ED as a last resort.
A patient may not have commercial insurance and therefore may not be able to use an urgent care center or obtain care through a retail pharmacy. The patient may not have a primary care provider. The ED becomes the place where that patient ultimately seeks care.
In that sense, increasing ED utilization can serve as a canary in the coal mine or a leading indicator. It can be a proxy for an eroding payer mix and for broader coverage problems in the community.
There is an especially interesting historical shift here. Six years ago, the No. 1 metric most highly correlated with positive hospital financial performance was ED volume. That relationship broke in 2020 and has essentially tipped sideways. ED volume is now, in many instances, more correlated with weakened financial performance. The metric that has moved into the stronger position is the use of primary care networks as a front door into the health system.
The increase in ED use is therefore increasingly a coverage issue rather than simply a gateway to hospital admission.
There is another dimension that ED visit counts alone do not capture: how long patients remain there. Boarding times have increased substantially. EDs are operating at much higher levels of utilization, with many patients remaining for extended periods.
Behavioral health is a major contributor. Many behavioral health patients are presenting to EDs and staying for a long time because it is difficult to find an appropriate placement elsewhere. The ED is consequently carrying not only more volume, but also more patients who require longer periods of care and for whom the hospital may have limited alternatives.
There are differences among hospitals in how these pressures are likely to affect them, but one important point is that no hospital is immune. The variation within individual groups of hospitals can be just as wide as the variation between groups. While the medians may differ, the statistical distinction between cohorts is not always strong enough to suggest that one particular category is protected.
That is important because almost all hospitals have experienced some of the changes described above.
Nevertheless, some groups of hospitals are particularly vulnerable. One is mid-sized hospitals, those with 100 to 300 beds. These hospitals often have meaningful commercial payer exposure, but they are not large enough to have the same ability to pull all of the operational and strategic levers available to a very large organization.
At the other end of the spectrum, very small hospitals often already serve highly vulnerable populations, so the incremental effect of some changes may be less pronounced. The middle of the distribution can therefore be especially exposed.
Hospitals in Medicaid expansion states are another important group. Medicaid expansion was beneficial during the pandemic, and hospitals in expansion states outperformed those in non-expansion states. But those hospitals now have more people on Medicaid than hospitals in states that did not expand Medicaid. As community engagement requirements and other changes are implemented, there is a greater potential, in expansion states, for patients to move from Medicaid to self-pay.
In this case, a policy change that helped hospitals in one period creates greater exposure in another.
Hospitals and health systems have a myriad of such actions to consider, and they need to think about them together.
One set of actions is strategic: Are we delivering care in the right place for the right patient? Strong ambulatory strategies, appropriate discharge planning, and continuation of care into post-acute settings can help manage costs by delivering care in lower-cost settings. Site neutrality is important in this context.
Hospitals need to understand their portfolio of services. Not every service produces the margin an organization needs, and not every service has the volume necessary to be financially accretive while also achieving the desired quality outcomes. A careful evaluation of the service portfolio is therefore essential.
Revenue integrity is another critical lever. Hospitals need to collect every dollar that is legitimately owed to them. Capturing and coding patients appropriately so that the hospital is paid for the acuity and complexity of the patients it treats is critically important. Clinical documentation improvement and related work can have a significant effect.
On the cost side, all of the traditional levers remain important. Specialty pharmaceuticals have been one of the largest sources of cost pressure. Drug costs are up approximately 6% over last year on a volume-adjusted basis, according to National Hospital Flash Report data, representing significant growth over the last several years. The response cannot be limited to negotiating lower prices. Contracting, group purchasing, utilization management, and making sure that patients receive the appropriate amount of goods and supplies are all part of the equation.
Many hospitals have already gone through substantial expense-control efforts and may need to go through another round. That is painful. Executives may wonder whether morale in their organizations is high enough for more serious cost containment. Once the organization understands where it needs to act, management has to determine whether it can execute those changes.
Health systems will also need to analyze their portfolios of facilities. For a large system, that means looking at every hospital. A 30-hospital organization may ultimately determine that it is better off with 25 hospitals than 30. Divestiture may be an option, and in some cases closure may be necessary. Closing a hospital is extraordinarily painful, but there is a growing recognition that the overall group of hospitals the country has carried for years may be more than the current environment can financially sustain.
The necessary work of analyzing portfolios of services is controversial inside hospitals and boardrooms.
Obstetrics and delivery is one example. Many people who work in a hospital and many board members do not think they have a real hospital if they do not have obstetrics. At the same time, there are communities where a woman may have to drive an hour or two hours to deliver her baby if the local service closes. The consequences can be very serious.
The choice, however, is increasingly stark in some parts of the country: A hospital may have to choose between closing obstetrics and keeping the hospital open or keeping obstetrics open and ultimately having to close the entire hospital.
Behavioral health is another area of sensitivity. The need for these services is enormous and growing. However, meeting this community need can create great financial pressure. Hospitals have frequently cross-subsidized behavioral health. As margins deteriorate, the question becomes how long that cross-subsidization can continue.
These decisions are made even more complicated by regulators and internal politics. A board and management team may determine that closing a service is necessary, only to encounter state regulatory barriers to doing so. Obstetrics, in particular, is highly controversial. Hospitals can have the internal fortitude to make a difficult decision and still be prevented from implementing it.
The country needs a more coherent approach on how obstetric services should be delivered, where they should be delivered, and under what conditions. Too much of the discussion is framed simply as open or close, rather than as a broader conversation about how the nation should organize these services.
The ability to interpret the numbers and then act on them is becoming just as important as the numbers themselves.
Hospitals used to be data poor. Then they became data rich and information poor. Now they are data rich and information rich, but in many cases interpretation poor. The problem is not necessarily the absence of a particular metric. It is understanding how a constellation of metrics works together and what the dynamics and interplay among them mean.
Many hospitals have a proliferation of reports and dashboards. But the most important question is not whether there are enough metrics. It is whether executives and boards understand how those metrics interact. What happens to inpatient and outpatient factors relative to margins? What does volume growth mean in the context of payer mix? What does a change in one metric tell us when another metric changes at the same time?
Executives and boards tend to follow absolute and comparative relationships, but they are often less attentive to the interrelationships. What conclusion can be reached if two things fall at the same time? That is where the industry needs to become smarter and more attentive.
At a minimum, a revised financial plan needs to be developed now. The question is not simply whether an organization is profitable today. It is what the organization will look like financially if these external forces continue and what operational and strategic adjustments will be required.
This should be managed as a planning matrix. Organizations should build a predictive model that shows what the financial position will look like if certain external changes occur. Then they should decide in advance which measures will be taken if those thresholds are reached.
If the model says that a certain set of circumstances will push the organization from a 1.5% positive margin to a 1.5% negative margin, management should already know what actions it will take. Those actions should be presented to the board in advance so that there is agreement about what happens when the specified thresholds are reached.
That is good management in the current environment: Build the matrix, understand the implications, establish the response, and obtain the board's agreement before the crisis arrives.
There is both a cost of inaction and a cost of wrong action. Organizations need the planning discipline to distinguish between them. Some hospitals are not acting quickly enough; others may be acting, but not necessarily on the right things. The magnitude of each problem varies, but both are real.
Looking across the frankly grim policy landscape, two broad areas deserve the greatest concern; the degree of concern will vary from market to market.
Changes to Medicaid financing in the wake of the 2025 passage of the One Big Beautiful Bill Act are potentially the largest single issue. These changes include Medicaid eligibility and community engagement requirements, limits on state provider taxes that fund a portion of the non-federal share of Medicaid spending, and the creation of payment limits for state-directed payments (SDPs).
In some states, governmental bodies have already begun to attenuate or remove SDP payments, while many others are discussing changes. In addition to limits on SDPs for services that were capped starting in 2025, SDPs that were temporarily grandfathered will be subject to payment cap reductions starting in 2028. Any significant reduction in supplemental payments could have a massive effect on hospital financial performance.
Beyond Medicaid, there are a series of other payer and coverage changes, including site neutrality and ACA enhanced advanced premium tax credits, that comprise a second major area of concern. These are not isolated changes. As with the Medicaid changes noted above, they interact with the underlying payer mix and can move patients from commercial coverage or Medicaid toward self-pay.
Also not to be discounted is ongoing scrutiny of the 340B Drug Pricing Program. Many hospitals have become highly dependent on the economics of 340B. There are organizations whose entire bottom line effectively comes from the program. Executives have described situations in which a hospital made a 3% margin and essentially all of that margin came from 340B. If 340B disappeared, the organization would be at breakeven.
There are also dozens of other macroeconomic factors, including inflation and cost pressures, that also require consideration.
When Sam Hazen, CEO of HCA, testified before the House Ways and Means Committee this past April about healthcare affordability, he correctly identified the root of the issue: “The starting point,” Hazen said, “is insurance coverage.”
That is the fundamental issue. Changes to ACA enhanced advanced premium tax credits and Medicaid can remove or reduce coverage from people, while hospitals are still required to care for those people. Hospitals can work to increase revenue. They can cut expenses. They can improve collections and coding, evaluate their portfolios, close or sell facilities and services, and pull every operational lever available to them. But they also need patients who are covered.
The numbers are producing very real consequences. Hospitals are operating on margins so thin that a relatively small change in coverage or payer mix can eliminate profitability.
Uncompensated care is rising. EDs are seeing more patients who lack adequate coverage and are increasingly serving as a last resort. Drug and other costs are rising. Supplemental payment programs and other financing and reimbursement mechanisms are under pressure.
The numbers are, in that sense, tyrannical. They cannot be talked away or maneuvered around indefinitely.
The hospitals that will navigate this environment most successfully will not necessarily be those that discover a single transformative solution. They will be those that understand the interaction among coverage, payer mix, utilization, revenue, cost, service portfolios, and community needs, and that are willing to act on that understanding before their margins disappear.
Managing Director, Founder
As one of Kaufman Hall’s founding partners, Ken Kaufman has provided the nation’s top healthcare leaders with expert counsel and guidance since 1976. He is recognized as a leading authority on healthcare macro trends, with his areas of expertise spanning strategy, finance, financial and capital planning, as well as mergers, acquisitions and partnerships. Ken offers deep insights into the economic,...
Managing Director, Financial Planning & Data Analytics
Erik Swanson is a Managing Director leading Kaufman Hall’s Data and Analytics Group. His responsibilities focus on building cutting-edge data science tools and leveraging big data to provide deeper and more timely insight, drive operational improvement, and develop thought leadership to help our clients and consultants achieve the most meaningful outcomes. His areas of expertise span artificial intelligence and machine...
