Dare I say it? Health system financial performance is trending positively. The last two quarters have seen operating margins continue to improve towards pre-pandemic levels and large investment returns boosted net income. With operating margins returning and the stock market at all-time highs, is now the time for focus to shift from surviving to thriving?
Consistent with previous blog posts (see Jan 2024, July 2023 and Oct. 2022), we’ll break our analysis down into two distinct measures of profitability: operating income and net income. As a reminder, operating income focuses solely on the hospital’s core operations, whereas net income provides a comprehensive view of the hospital’s profitability after considering all financial activities. The key difference for hospitals is typically the inclusion of investment income or losses in net income.
Operating Profits are Trending Towards Pre-Covid Levels
According to S&P Global, the annual median health system operating margin ranged from 2.2% to 3.6% in the decade leading up to the Covid-19 outbreak. After experiencing years of low margins or even losses, quarterly operating margins are trending toward the pre-Covid range. While recovery has been inconsistent from quarter to quarter, there is a clear positive trend, which is great news for health systems. A quarterly breakdown since the start of 2022 is shown in the chart below.[1]
With median margins trending positively, we are seeing an increase in the percentage of health systems operating at a profit. As shown below, more than two-thirds of the 125 largest U.S. systems operated at a profit in the first quarter of 2024. This is much better than what we saw in 2022 and early 2023 when only one-half of systems generated a profit.
Salaries and Wages Continue to Decline
A trend we are seeing in health system financials is a decline in salaries and wages as a percentage of net revenue. With staffing shortages in 2022 and early 2023, we saw these expenses rise dramatically as systems were required to utilize contract labor or pay premiums for many roles. Over the last four quarters, we’ve seen salaries and wages stabilize at lower levels.
While we may not be in the clear just yet, this is a positive sign for health systems and is likely an important driver in the improving operating margins discussed above. If health systems can continue to reduce salary and wages as a percentage of net revenue, it should help boost operating margins further.
Investment Income Drives Net Income
As we’ve discussed in previous blog posts, health systems have some degree of control over operating margins. But if one thing remains clear from the chart below, it’s that investment income is the key driver of net income at health systems – and markets are entirely beyond any leader’s control. As the stock market increases, the net income margin shows significant profitability. As the stock market declines, the net income margin quickly turns negative.
Ultimately, operating margins represent just a small portion of the net income margin.
What to Expect for Q2 Financial Statements
Operating Income: Though operating margins are still running below their historical average, it appears that revenues and expenses continue to stabilize. We expect this trend to continue into the second quarter.
Net Income: Investments are expected to positively drive health system bottom lines again in the second quarter of 2024. While the Dow Jones was down 1.7% for the quarter, the S&P 500 and Nasdaq closed near all-time highs, up 3.9% and 8.3% for the quarter, respectively. This suggests another period of investment income driving net income.
Conclusion
In recent years, many health systems hoarded cash and delayed capital expenditures in response to immense financial pressures. With stock markets near all-time highs and operating margins returning to pre-Covid levels, it may be time to shift out of survival mode and begin looking for opportunities to expand your footprint, invest in new equipment, or offer new services to your community.
Tread carefully, however. If you shelved growth plans in 2020, you might be surprised how much your market has changed since then (not to mention regulation and technology). It’s always good to check your assumptions with every new strategy cycle – and that advice has never been more pertinent than it is right now.
Research support provided by Stephenie Fahy, senior financial analyst
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[1] Although health systems utilize a variety of fiscal years, our analysis focused on distinct three-month periods. Q1 refers to January 1 - March 31. Q2 refers to April 1 - June 30. Q3 refers to July 1 - September 30. Q4 refers to October 1 – December 31.
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