Intuitively, you would think that the closer a commercial venture is to 100% full, the more profitable that venture would be. For example, airlines overbook their flights so that they can...
When a hospital runs a positive margin and makes money at the end of the year, everyone wants some of it – hire more doctors, hire more nurses, buy a new MRI machine, build a new hospital wing. It can be tempting to spend it all but should you? Liquidity is survival insurance for a hospital and it is essential to hold some money back. Every individual person should have an “emergency fund” with 2-6 months of expenses held in a checking/savings/money market account, and so should hospitals. These cash reserves are called “days cash on hand” and represent the amount of money it takes to pay all of the hospital’s expenses for that number of days.
A few year ago, Dr. Charles V. (Bo) Sanders gave a presentation at the annual Association of Professors of Medicine meeting that I was attending. He is the Chairman of the Department of Medicine at LSU School of Medicine in New Orleans and was describing the effect of Hurricane Katrina on the hospital and his department. Katrina flooded Charity Hospital which then closed, displacing most of the doctors in his department. With limited cash reserves, the hospital could not pay physician salaries and many of the doctors and nurses moved on. The hospital essentially died and was never able to reopen.
Charity Hospital is just one example of why a hospital needs to have sufficient days cash on hand but there are many things other than hurricanes that can temporarily close a hospital and require it to draw from cash reserves to cover payroll so that all of the employees don’t leave. Fire, flood, lapse of malpractice insurance coverage, prolonged power outage, unpredictable admission rates, you can think of a dozen other reasons that a hospital might have to reduce or close operations for a day, a week, a month, or longer.
In 2011, Moody’s Investors Service reported on the financial statements of 400 hospitals in their database. The overall median number of days cash on hand was 165 with a mean of 183. The range was from 11 days to 521 days. A 2013 analysis of critical access hospitals reported a median of 68 days. More recently, in 2015, Moody’s reported that the average for 350 hospitals and health systems had increased to 212 days. A 2014 Fitch Ratings report of nonprofit hospital and healthcare systems found that the credit rating of the hospital correlated with the number of days cash on hand with the “AA” hospitals having 289 days cash on hand and hospitals having a “BBB” rating only having 161 days cash on hand. A 2016 report by S&P Global Ratings indicated that “AA+” hospitals had 420 days cash on hand whereas “BBB+” hospitals had 149 days cash on hand; speculative grade hospitals (those that finance with “junk bonds”) had only 74 days cash on hand. The implication is that if your days cash on hand is high, the hospital’s credit rating is high and consequently, the hospital can get a better interest rate on bonds to do expansion, etc. In other words, more cash on hand equates to lower interest rates for loans.
From this analysis, it appears that the number of days cash on hand that is held by hospitals appears to be increasing over the past decade. I believe that there are at least three reasons. (1) The economic recovery since the great recession has led to overall better financial positions of U.S. hospitals. (2) Medicaid expansion (by those states that elected to participate) has led to a reduction in uninsured patients and this translates to improved margins. (3) Better analytics that are attendant to electronic medical records, better inventory management programs, and improved staffing programs has resulted in better hospital operational efficiency as well as better hospital billing efficiency.
There are a number of factors that can influence the ideal number of days cash on hand for any given hospital:
- Geographic location. Hospitals in areas vulnerable to natural disasters are themselves vulnerable to unexpected closings. For example, hospitals in low-lying coastal cities are vulnerable to flooding – Charity Hospital is an example of this. Other geographic vulnerabilities include susceptibility to regional wildfires, tornados, and earth quakes.
- Centralized versus decentralized. A hospital system built around a single large hospital (standalone hospital) is more vulnerable to closing operations than a hospital system with multiple buildings in different locations in the region. For example, if a water line breaks and floods the operating rooms taking them out of commission for 3 months to renovate, the centralized hospital will have no place to perform surgeries whereas the decentralized hospital system can redirect surgeries to alternative locations. The S&P bond rating analysis confirms this and indicates that standalone hospitals that had a “AA” bond rating had 100 more days cash on hand than decentralized health systems.
- Need for borrowed money. A hospital that is planning a $750 million expansion is going to need to borrow money by selling bonds. The current interest rate on a 20-year AAA rated municipal bond is 3.00% whereas an A rated bond is 3.50%. That is a $3.75 million dollar per year difference and over the course of the bond, a total of $75 million dollars additional cost for just that slight increase in the interest rate on the bond. For a “B” rated hospital, the difference in the interest rate that they can get on a bond can be even more, up to a full 1% higher. A hospital with a higher number of days cash on hand will be able to get a better bond rating.
- Need to pay off borrowed money. Most hospitals will have both cash and loans. If those loans were taken out at relatively high interest rates, then it may be more desirable to pay them off using the hospital’s cash. This can reduce the number of days cash on hand but can strengthen the hospital’s long-term financial position.
- Competitiveness of the regional health insurance market. When hospitals negotiate rates with commercial health insurance companies, one of their greatest leverage points is the ability to walk away from the table. By that I mean, the ability to tell the insurance company that if they won’t give the hospital the reimbursement rates that the hospital wants, the hospital will stop taking patients covered by that insurance company. If that hospital is the only hospital in a 50-mile radius, then they have a pretty good bargaining position because the insurance company can’t easily send their patients to another hospital. On the other hand, if there are a number of other hospitals in the community, then the hospital has less leverage because the insurance company can simply redirect its insured patients to another hospital in town. If such a hospital has relatively few days cash on hand, then the commercial insurance company will know that the hospital really has no bargaining position since they don’t have the resources to survive a sudden drop in admissions if the insurance company sends them all to a competitor hospital. On the other hand, if such a hospital has a lot of days cash on hand, the threat of walking away from the table is much more real and that stronger negotiating position is more likely to translate into higher reimbursement rates from the insurance company. Thus, a hospital in a region with other competing hospitals needs to have more days cash on hand in order to effectively compete for the best insurance reimbursement rates.
- Anticipated large capital purchases. Hospitals will not generally sell bonds for purchases such as a new electronic medical record but these can be quite costly and are better paid for out cash. If the hospital plans on buying a new EMR or some other large-priced purchase in the next few years, then it it best to increase the days cash on hand in anticipation of that purchase.
- Admission fluctuation. Our hospital in Central Ohio has a fairly consistent number of admissions per month; it tends to go up during the influenza season but otherwise is fairly constant. On the other hand, a hospital in a ski resort community in Colorado may see a significant rise in admissions in the winter whereas a hospital in the Outer Banks of North Carolina may see a significant rise in admissions in the summer. Hospitals with greater fluctuation in admissions and ambulatory visits will need to have more days cash on hand than those with very predictable admissions and visits.
- Medicaid expansion. Between 2010 and 2018, 83 U.S. hospitals went out of business. The overwhelming majority of these were in states that did not expand Medicaid under the Affordable Care Act. In all, 19 states did not expand Medicaid and 63 of the hospitals that closed were in these states. That means that 76% of all hospitals that closed were in these states. Six of these states had more than 5 hospitals close: Alabama (5), Mississippi (5), North Carolina (5), Georgia (6), Tennessee (8), and Texas (14). Hospitals in states that did not participate in medicaid expansion have been faced with higher numbers of uninsured patients and are at a competitive disadvantage to hospitals that did expand Medicaid. Having a larger number of days cash on hand is desirable for hospitals in states that did not expand Medicaid.
- Donor attractiveness. Wealthy donors are wealthy because they have a lot of financial sophistication. Donors will often examine the financial viability of a hospital before committing large endowments: why donate to a hospital that is on the verge of going out of business? More days cash on hand is one way of demonstrating the hospital’s financial solvency and stewardship. More days cash on hand can translate to larger endowments from wealthy donors.
Although having a large number of days cash on hand sounds good, too high of a number can be bad. For example, it may be better to invest that money in a better-paying investment, for example expanding the hospital’s primary care base by hiring additional primary care physicians. Or, if the hospital’s quality metrics are below average, it is better to spend additional money to improve patient satisfaction, decrease hospital readmissions, or improve the infection control efforts. For public hospitals that are owned by the city, county, or state, having too high a number of days cash on hand can create a perception to lawmakers and the public that the hospital is hoarding the public’s money.
So, what is the best number of days cash on hand? From this post, it should be clear that there is not a single best number for all hospitals. I’d start with a number of about 300 for standalone hospitals and about 250 for hospital systems. Then move that number up or down depending on all of the variables mentioned above. For a decentralized health system in a Medicaid expansion state that does not have excessive natural disaster risk and does not anticipate purchasing large amounts of bonds, 130 days may be plenty. On the other hand, a centralized standalone hospital in a competitive market in a state that did not participate in Medicaid expansion and is at risk of natural disasters and also plans on a major building expansion requiring bond sales, 400 days may be more desirable.
The number of days cash on hand is something that physicians rarely think about and almost never incorporate in their decision-making about whether to take a job at a hospital. But I think that physicians should take notice of this number and if it is too low, ask the hospital administrators why it is low. If you can’t get a good answer, think long and hard about whether that hospital represents a risky career choice.
May 5, 2018