SPECIAL COMMENT

U.S. PUBLIC FINANCE

MAY 21, 2014







Table of Contents:
IT SPENDING IS NECESSARY BUT
COSTLY 2
HOSPITALS ARE RAMPING UP
INVESTMENT IN OUTPATIENT
STRATEGIES 2
THE RISE OF PRICE SENSITIVITY IS
CREATING NEW COMPETITORS 4
MOODYS RELATED RESEARCH 6

Analyst Contacts:
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Brad Spielman +1.415.274.1719
Vice President - Senior Credit Officer
brad.spielman@moodys.com
NEW YORK +1.212.553.1653
Lisa Martin +1.212.553.1423
Senior Vice President
lisa.martin@moodys.com
Kendra M. Smith +1.212.553.4807
Managing Director - Public Finance
kendra.smith@moodys.com




Building Value: Investments Aimed at
New Priorities Create Opportunities for
Not-For-Profit Hospitals

Hospital systems that are focusing investment dollars on information technology, outpatient
services and improved efficiencies will be best prepared to mitigate the negative impacts of
declining inpatient utilization, shifting payer models and increased competition from
nontraditional participants in the healthcare industry.
Due to growing consumer price sensitivity and the growth of consumer choice, the ability for
hospital systems to offer value will be a driver of success. Strategic and appropriate investment
in information technology (IT) and outpatient services should be a long-term credit positive,
but this type of expenditure frequently has an immediate negative impact on income
statements and balance sheets, depending on the size and success of the investment.
There are three areas of primary consideration:
IT spending is necessary but costly: Achieving value can be expensive, and there is an
immediate consequence to high IT investment.
Hospitals are ramping up investment in outpatient strategies: Declining inpatient
utilization and the shift to outpatient services are reducing hospital revenues, spurring
hospitals to make greater investments in ambulatory capabilities and physician
recruitment.
The rise of price sensitivity is creating new competitors: Driven by heightened consumer
price sensitivity, new competitors are beginning to enter the outpatient arena and defining
what value means.





U.S. PUBLIC FINANCE
2 MAY 21, 2014

SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS

IT spending is necessary but costly
Many organizations have hitched their pursuit of value to the acquisition and implementation of
comprehensive and expensive IT systems. The return on these investments can be allusive, while the
cost can immediately weaken both income statements and balance sheets.
1

Spurred in part by financial incentives built into the Affordable Care Act (ACA), hospitals have
escalated spending on IT systems with many systems announcing large, big-bang system conversions.
In many instances, these projects represent significant portions of the organizations capital budget
over a period of several years. For large systems, the total cost can near, or exceed, a billion dollars.
Depending on project configuration, much of the cost may be expensed rather than capitalized,
reducing operating income. Also significantly, these projects can increase debt, decrease cash, or both.
Stage I of the Meaningful Use provision of the ACA has provided approximately $22.5 billion of
supplemental funding to hospitals since 2011, yet in all cases that we have reviewed, the cost of an
acquired IT system has dwarfed the Meaningful Use funds received.
The short-term credit implications are generally neutral to negative, depending on the size of the
investment and the success of the initial implementation. Rocky conversions can result in a spike in
accounts receivable, decreased cash flow and lost revenue. Among rated hospital systems, the impact
has varied, with some systems reporting significant margin degradation during implementation and
other systems experiencing minimal impact.
Longer term, a well-functioning IT system that integrates electronic medical record management,
clinical oversight, billing, revenue management and customer interfacing may well be a minimum
requirement for organizational success, especially among larger systems. A comprehensive IT system
that has been implemented successfully and is integrated into the strategy and culture of an
organization can be key to an organizations value proposition, and be a long term-credit positive.
Hospitals are ramping up investment in outpatient strategies
The shift to observation stays and outpatient services is resulting in decreased inpatient utilization and
lower hospital revenue.
2
Hospital systems that can supplement inpatient revenue with new, diversified
revenue streams are more likely to remain successful and enhance consumer value. These investments
are generally less expensive than building inpatient capacity and can help mitigate inpatient utilization
declines.
As indicated in our fiscal year (FY) 2013 preliminary medians, median revenue growth dropped in FY
2013 and remains among the lowest in recent years. Concurrent with this drop, median expense
growth also dropped but not by as much, leading to median margin degradation. This is the second
year in a row that expenses grew at a rate higher than revenues (see Exhibit 1).

1
Moodys Investors Service, 2014 Outlook US Not-for-Profit Hospitals
2
Moodys Investors Service, Profitability and Revenue Growth Drop in US Not-for-Profit Hospital Preliminary Medians
This publication does not announce
a credit rating action. For research
publications that reference Credit
Ratings, please see the ratings tab
on the issuer/entity page on
www.moodys.com for the most
updated Credit Rating Action
information and rating history.



U.S. PUBLIC FINANCE
3 MAY 21, 2014

SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS

EXHIBIT 1
Revenue Growth Remains Low and Continues to Trail Expense Growth


Source: Moodys Investors Service; 2013 is based on audited financial statements of 203 organizations; the data prior to 2013 are from different sample sets.
However the multiple years of data accurately reflect the trend in the industry over this period.

A major driver of suppressed revenue growth is the shifting utilization trends. Per our FY 2013
preliminary medians, median admissions have been relatively flat over the last two years (increasing
slightly from 23,215 in FY 2011 to 24,027 in FY 2012, and then dropping slightly to 23,380 in FY
2013) while median outpatient visits have grown significantly, increasing from 298,927 in FY 2011 to
319,886 in FY 2012, and increasing further to 345,870 in FY 2013 (see Exhibit 2).
EXHIBIT 2
Admissions Remain Stagnant While Outpatient Visits Rise

Source: Moodys Investors Service

Observations stays, which pay less than inpatient admissions, have also increased significantly in recent
years. In FY 2012, the median growth rate of observation stays was a significant 10.4% and in FY
2013 it was 8.0% (see Exhibit 3).
3%
4%
5%
6%
7%
8%
9%
10%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Median Annual Revenue Growth Rate Median Annual Expense Growth Rate
250,000
270,000
290,000
310,000
330,000
350,000
370,000
15,000
17,000
19,000
21,000
23,000
25,000
27,000
29,000
2011 2012 2013
Admissions Outpatient Visits



U.S. PUBLIC FINANCE
4 MAY 21, 2014

SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS

EXHIBIT 3
Median Observation Stays Increase Significantly

Source: Moodys Investors Service

Many hospital systems began preparing for this shift several years ago by investing in outpatient service
centers and urgent care centers. Several communities have seen a marked increase in the number of
urgent care centers, large full-service outpatient centers and even stand-alone emergency departments.
In some cases, the facilities are large, costing hundreds of millions of dollars and rivaling the capital
cost of inpatient facilities. In most cases, however, the capital costs are more modest and represent
enhanced value, operating at a lower cost. Hospital systems that are not successful at adapting business
strategies and creating additional revenue streams run the risk of losing both revenue and market share.
A challenge with a more outpatient-oriented business strategy is the need to further align with both
primary care physicians and specialists in order to provide both volume and staffing for outpatient
facilities. Hospitals are engaging in a variety of strategies to achieve this, including forming joint
ventures, purchasing physician practices and offering independent physicians incentives (such as
participation in an IT system). Acquiring physician practices is the most direct method to create
physician alignment, but it is also the most expensive.
The rise of price sensitivity is creating new competitors
Growth in high deductible plans and private exchanges is driving consumer price sensitivity, which is
in turn driving growth in less expensive outpatient services. Nontraditional competitors are
responding, and healthcare services provided by drugstores and unaffiliated outpatient centers are
diverting volumes and revenues from traditional hospital providers. Hospitals will need to make
additional investments or form partnerships in order to effectively compete.
Over the last several years, the popularity of high deductible plans has increased, which has been
concurrent with an increase in bad debt as measured on a median basis (see Exhibit 4). This shift is a
further driver of reduced hospital revenue growth. This trend is also apparent in the rise of other
alternative insurance models, which hospital systems are attempting to prepare for by upgrading IT
systems. As the dominant healthcare model in the country shifts from volume to value, income
pressures will increase, putting hospitals income statements at further risk.
4,797
5,736
6,263
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
2011 2012 2013



U.S. PUBLIC FINANCE
5 MAY 21, 2014

SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS

EXHIBIT 4
Bad Debt Grows with Popularity of High Deductible Plans

Source: Moodys Investors Service; Kaiser Family Foundation

The increase in consumer price sensitivity and the demand for increased pricing transparency is a
further consequence of the rise of high deductible plans. Nontraditional participants have responded to
this opportunity by significantly growing retail medicine. There are currently approximately 1,600
retail-based walk-in medical clinics across the country
3
, and it is estimated that this number will
double over the next three years.
4
This shift towards retail medicine is driving volume and revenues
away from hospital systems and other traditional providers. As retail medicine grows and begins to
incorporate other services, it will become an increasing threat to hospitals income statements.
Retail medicine is changing how consumers view value within healthcare services. In so far that value
means higher quality at lower cost, consumer focused delivery is helping redefine high quality as
convenient. This shift represents a serious threat to hospitals because they will have a hard time
competing based on convenience and their overhead for the same services is significantly higher.
Hospitals will either cede this territory and attempt to make up the lost revenue elsewhere, or they will
need to form partnerships or find other ways to compete. Some hospitals have begun investing in self-
branded retail services located within malls and other venues. The returns on these investments so far
are mixed, and are reliant on generating additional patient referrals back to the hospital. In the final
analysis, hospitals will find ways to more effectively compete, diversify revenues, and offer enhanced
consumer value, or they will likely lose market share and income. Hospitals that can build true
consumer value are more likely to have long-term success.


3
Convenient Care Association
4
Accenture, Retail Medical Clinics: From Friend to Foe?
0%
5%
10%
15%
20%
25%
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
2009 2010 2011 2012 2013
Median Bad Debt ($000) People in High Deductible Plans (%)



U.S. PUBLIC FINANCE
6 MAY 21, 2014

SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS

Moodys Related Research
Median Report:
Profitability and Revenue Growth Drop in US Not-for-Profit Hospital Preliminary Medians,
April 2014 (167463)
Sector Comments:
US Healthcare Reform: Three Risks Reduce Credit Positives for Not-for-Profit Hospitals, March
2014 (166602)
Two-Midnight Rule Will Reduce Revenue for Most Hospitals, March 2014 (165866)
Federal Proposal Helps Essential Hospitals But Discourages Narrow Networks, March 2014
(165635)
Special Comment:
Academic Medical Center Hospitals Maintain Stronger Credit Characteristics Than Other Not-
for-Profit Hospitals, January 2014 (162049)
Industry Outlook:
2014 Outlook US Not-for-Profit Hospitals, November 2013 (160569)
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of
this report and that more recent reports may be available. All research may not be available to all clients.










U.S. PUBLIC FINANCE
7 MAY 21, 2014

SPECIAL COMMENT: BUILDING VALUE: INVESTMENTS AIMED AT NEW PRIORITIES CREATE OPPORTUNITIES FOR NOT FOR PROFIT HOSPITALS



Report Number: 170100
Author
Brad Spielman
Production Specialist
Wendy Kroeker







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