A majority of the state’s hospitals saw their financial condition deteriorate over the last decade to the point where they had negative operating margins and, in a potential crisis for the health care system, could close should economic conditions grow worse.

Moreover, the last 10 years saw a growing gap between financially strong and weak hospitals, with both performing poorer as the decade ended, but with weak hospitals experiencing an even sharper decline.

Those are the conclusions of a new report for the California HealthCare Foundation assessing the condition of the hospital industry in light of a state law requiring it to spend billions of dollars to seismically strengthen patient facilities.

While previous studies have shown that California hospitals are losing money, the 141-page report by Shattuck Hammond Partners, an investment banking firm specializing in health care, is the most detailed analysis yet.

The report labels the decline of the hospital industry “another crisis in the making” on par with energy, education and other serious challenges.

The report, a draft copy of which was obtained by the Business Journal, found that the median operating margin of 409 acute care hospitals fell to -0.33 percent in 1999 from 1.65 percent in 1995. That means more than half of all hospitals were losing money by the end of the decade.

Even more disturbing, the study found a growing gap between what it termed “have” and “have not” hospitals.

The top quarter of hospitals saw their operating margins drop in the five-year period to 5.72 percent from 6.84 percent, while the bottom quarter saw their negative margins grow to -7.76 from -3.96.

Worse in Southern California

The study found that hospitals in Southern California were doing worse than those in the northern part of the state. The median operating margin here fell to -0.53 in 1999 from 1.44 percent in 1995, while in Northern California it dropped to a razor thin 0.10 percent from 1.97 percent.

The poor financial results are blamed on a health care environment marked by strong business purchasing alliances that have held down insurance premiums, low Medi-Cal reimbursement rates, high managed care penetration, sicker patients, higher wages, a growing nursing shortage and a larger uninsured population.

With the exception of a handful of case studies, the report did not examine individual hospitals but analyzed the data in aggregate, finding weak hospitals often were small, rural, run by public agencies or independent. For-profit, larger hospitals were among the best performers.

“You can quibble with some of the numbers, but this report shows that overall California hospitals are in a serious financial condition,” said Jan Emerson, vice president of public affairs for the California HealthCare Association, the industry trade association. “The financial pressures of California hospitals are deep.”

The report also warned that as a whole the state’s hospital industry is incapable of absorbing vast new capital expenses, such as those that will be imposed by the earthquake law or a new federal mandate requiring hospitals to improve the privacy of patient medical records.

It reviewed credit ratios such as “days cash on hand” and “debt to capital” to conclude that all hospitals saw a significant decline in credit strength over the latter half of the decade.

By the measure of days cash on hand, half of the hospitals had 50.9 days or less. By comparison, the median figure for companies nationwide that received Moody’s Investor Services Baa” rating one step above a junk bond was 92.7.

Thus the bottom quarter of state hospitals would probably be unable to borrow money in the public capital markets.

Need for financial assistance

Dr. Elaine Batchlor, vice president of the healthcare foundation, a leading state think tank, said the study supports the idea that some hospitals will need financial assistance to meet the seismic mandate or they could be forced to shut down.

“There are some hospitals in a strong financial position, but there are many hospitals in a weak financial condition,” she said.

“There does need to be some thought given to which hospitals are providing essential services and which are financially vulnerable.”

The hospital industry claims the seismic law could cost them as much as $24 billion over the next 30 years, and is seeking assistance in the form of a state bond measure. However, a Rand Corp. report also commissioned by the foundation places that cost below $5 billion.

The law requires that hospitals improve their facilities by 2008 so that they will be able to withstand an earthquake, while a second 2030 deadline requires them to remain operational. Failure to meet the deadlines requires them to shut down, though a bill that appears on its way to passage in the legislature would give hospitals a five-year break from the initial deadline.

A University of California at Berkeley study released in May found that already 23 hospitals closed in the state from 1995 to 2000, including 11 in Los Angeles County and four in the San Diego area.

The study blamed the closures on low profit margins, and cited low Medi-Cal reimbursement rates, high numbers of uninsured, as well as initial costs for seismic retrofitting among the factors.

However, it’s not clear the hospital industry remains in such critical condition, given evidence that hospitals have been able to negotiate higher reimbursements from insurers over the past two years.

Batchlor agreed there are anecdotal reports hospitals are doing better by winning more generous reimbursements, but she maintained that is only one factor in determining their financial condition, leaving out critical issues such as expenses.

Even so, the report did not convince everyone that the hospital industry is in dire straits and in need of hand outs.

Maura Kealey, health care coordinator with the Service Employees International Union, the largest health care union in the state, claimed that a careful analysis of the study shows that hospitals serving 80 percent of the state’s population are operating profitably.

She contended that conclusions drawn from looking at the median figures the point at which half the hospitals are above and half are below allows numerous small, rural hospitals to skew the results.

“The median hides the multitude of sins,” Kealey said. “The bottom line here is that you have to look hospital by hospital to see whether they have financial problems.”