Critical Access Hospitals: 5 Troubling Financial Signals for 2022

Business & Financial Planning

From a strictly financial standpoint, the Covid pandemic steadied the outlook for Critical Access Hospitals (CAH) across the United States, but all five factors responsible for that trend have now reversed sharply, suggesting a looming crisis.

Perhaps the easiest way for hospitals to remain financially secure through periods of uncertainty is with a strong days cash on hand – the number of days a business can continue to pay its operating expenses with the current cash it has available.

Early in the pandemic, a unique combination of economic, fiscal, and policy changes led to a dramatic increase in average days cash on hand, helping to stabilize CAH balance sheets and prepare them for an unknown future.

Here’s one way to capture the extent of the change: A Critical Access Hospital was as likely to have 180+ days of cash in FY 2020 as it was to have 60+ days of cash in FY 2019. But now, the same factors that led to this improvement in FY 2020 are primed to send days cash on hand tumbling in FY 2022, based on Ascendient’s analysis of 1,329 Critical Access Hospitals utilizing Optum’s ECG Quick Connect Financial Benchmarks (June 7^th data set).

Days cash on hand is calculated by dividing cash and cash equivalents by operating expense per day. The five factors below will either decrease cash and cash equivalents (the numerator) or will increase operating expenses (the denominator), thus reducing days cash on hand.

Federal Pandemic Programs

The U.S. government took swift action to approve the Coronavirus Aid, Relief, and Economic Security (CARES) Act providing funds to support healthcare providers. The funding was used to support healthcare-related expenses or lost revenue. More than 85 out of every 100 CAHs saw an increase in other nonpatient revenue in FY 2020, likely as a result of the CARES Act. The average CAH increase in other nonpatient revenue was nearly $2 million, which was more than the average net income of $1.7 million. With most CAH recognizing CARES Act funds in FY 2020 and/or FY 2021, other nonpatient revenue is expected to drop in FY 2022, reducing CAH profits.

In addition to funds provided through the CARES Act, CMS administered the Medicare Advance Payment program which advanced payments to hospitals. These payments were prepayments that each hospital will repay, either through the delivery of future goods or services to Medicare beneficiaries or through repayment of the advance. Said another way, CAHs will have to provide services and pay the expenses associated with those services while not receiving additional cash, or CAHs will have to make a cash payment back to CMS. Either way, the CAH cash balance will be negatively impacted in FY 2022 if it still has Medicare Advance Payment liabilities.

Capital Expenditures

As is typical in times of uncertainty, capital expenditures declined in 2020 as healthcare systems continued to accumulate cash and cash equivalents. Three out of every five CAHs increased gross fixed assets by less than depreciation expense. This means CAHs aren’t replacing the utilized value of their existing fixed assets. Delays in capital expenditure can expedite costs in future years as equipment or facilities age and break down, including a potential need in 2022 which would reduce cash balances.

Investments

“Cash on hand” is a tricky term because most hospitals aren’t stuffing cash under the mattress – they’re investing it in bonds and mutual funds. That was a great strategy during the pandemic, but it’s problematic in the current bear market.

A CAH that invested its extra cash, whether from the CARES Act, Medicare Advanced Payments, or through normal operations, would have experienced significant investment income potential in 2020 and 2021, likely improving net income and increasing the value of cash and cash equivalents.

But 2022 has been a different story. Halfway through the year, the Dow was down about 18%, while the S&P 500 dropped 23%. Bond values have also declined in the face of rapidly rising interest rates. This will negatively impact Critical Access Hospitals in two ways. First, investment income on the income statement will likely be negative as investments decline in value, increasing the probability of net losses. Second, the value of these investments will decline, reducing cash and cash equivalents which will reduce days cash on hand.

Interest Rates

To mitigate the pandemic’s economic impact, the Federal Reserve left interest rates near zero percent for two years. However, that changed quickly in 2022 with rate increases in March, May, and June – a change that will affect both new and existing debt at Critical Access Hospitals.

For any CAH that needs to issue debt or take on additional financing, it is now more expensive to do so. In addition, many forms of financing have interest rates tied to benchmarks such as LIBOR rates. As these benchmarks rise, so will interest expense. Critical Access Hospitals that took out debt during the last two years may now be paying significantly higher interest rates in FY 2022. Rising interest rates impact days of cash negatively by reducing cash and cash equivalents (decreasing the numerator) and by generating additional expenses (increasing the denominator).

Operating Expenses

Even before the pandemic, expenses in the healthcare industry were rising faster than the broader economy, due to increasing staffing costs and rapidly increasing drug and supply expenses. In FY 2020, the average CAH saw total expenses increase by 4%, over three times the rate of inflation in the United States. Now that inflation is more widespread, the pressure on hospitals is only increasing.

In 2022, hospital expenses are being hit by inflation, labor shortages, excess contract labor expenses, and supply chain challenges. According to Syntellis, in April 2022 U.S. hospitals and health systems saw labor expense per adjusted discharge up 15%, total expense per adjusted discharge up 10.1%, and operating margins down 77.9% compared to April 2021. Even a small increase in expenses will have a negative impact on days cash on hand; but an increase of this magnitude will multiply the decline and intensify any cash shortages.

Conclusion

Critical Access Hospitals were able to endure the pandemic thus far with stronger-than-normal balance sheets, particularly because of strong cash on hand. The same factors that led to this strength are now poised to reverse the trend. With the Medicare Advanced Payment liabilities coming due, a need for capital improvements, declining investment income, rising interest rates, and rapidly increasing expenses, cash and cash equivalents will be squeezed from every direction.

Leaders at Critical Access Hospitals should do five things now to prepare for the likely decline in days cash on hand: 1) project where the year-end cash balance will be; 2) ensure bond and loan covenants will be met; 3) perform financial feasibility analysis for all capital expenditures; 4) identify ways to reduce expenses; and 5) communicate expectations with all stakeholders.

If your CAH lacks in-house expertise in financial planning and analysis or needs a fresh perspective, then consider getting an outside opinion. It’s a one-time investment that can generate positive, long-term returns at this critical inflection point.