H2C INDUSTRY INSIGHTS
 

Did Capitated Revenue Give Health Systems an Edge During the Pandemic?
H2C Analysis Suggests ‘Yes’

April 2021

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As volumes for hospitals and health systems fell throughout the pandemic, rating agencies speculated that organizations with capitated revenue from provider-sponsored health plans (“PSHPs”) and or capitation agreements would benefit from financial stability . The reason: Even as these organizations faced decreased revenue from postponed elective procedures, such pressures would be balanced by the cash flow of their PSHP, projected to reach all-time highs.

 

An H2C Securities Inc. (“H2C”) analysis aligns with that view, as PSHPs helped health systems weather the financial storm of COVID-19.

 

H2C analyzed the performance of the 25 largest not-for-profit health systems in the United States before and during the pandemic, comparing quarterly performance from Q1 2019 through Q3 2020. As part of the analysis, H2C measured PSHP premiums and capitation revenue as a percentage of each system’s total revenue by quarter during the defined period.

Assessing The Impact

H2C defined four unique health system tiers based on these criteria:

 

  • Systems with greater than 20% of total operating revenue attributable to PSHP premiums and capitation (Tier 1)

 

  • Systems whose revenue attributable to PSHP premiums and capitation equaled between 10% and 20% of total operating revenue (Tier 2)

 

  • Systems whose revenue attributable to PSHP premiums and capitation equaled less than 10% of total operating revenue (Tier 3)

 

  • Systems that did not disclose health plan revenue, often due to the absence of a significant PSHP (Tier 4)

The analysis specifically compared the operating cash flow margins at each system, calculating each unique tier’s averages. Importantly, H2C adjusted for CARES Act funding, removing recognized CARES Act revenue from the income statement to define the “CARES Act Adjusted Operating Cash Flow Margin.” The removal of CARES Act funding created an even field for health system comparison.

H2C’s analysis revealed:

  • The larger the percentage of revenue attributed to PSHP premiums and capitation, the stronger the system’s CARES Act Adjusted Operating Cash Flow Margin during Q2 2020 when the pandemic emerged. This period had the most significant impact on hospital margins due to the sudden drop in elective procedures, increased expenses to deal with the pandemic, and, depending on the system, costs of care related to COVID-19.

  • Adjusting for the CARES Act, systems with greater than 20% of revenue attributable to PSHP premiums and capitation saw a minor impact on their operating cash flow margin. Organizations in the 10% to 20% tier experienced the second-smallest effect on operating cash flow margin, followed by hospitals whose PSHP premiums and capitation revenue equaled less than 10% of operating revenue. Systems that did not appear to have a PSHP demonstrated the poorest performance.

FIGURE 1

When elective procedure volumes began to return in Q3 2020, systems with less operating revenue attributable to PSHP premiums and capitation outperformed those whose PSHP premiums and capitation revenue comprised greater than 20% of adjusted operating revenue. Meanwhile, operating revenue for Tier 1 systems—those with greater than 20% of adjusted operating revenue attributable to PSHP premiums and capitation —improved, but to a lesser degree.

FIGURE 2

It is important to note that margins may continue to shift as volumes change in the future. COVID-19 was unique, and future events (e.g., recessions, pandemics) may not yield the same results.

Additionally, costs may increase in the future due to patients needing care that was deferred, and perhaps even more expensive care as some patients face consequences for deferring care. H2C will continue to monitor these trends in future quarters.

A Predictor of Future Performance?

H2C’s analysis highlights that the membership-based structure of a health plan provides a reliable stream of revenue, and when combined with lower costs when members elect not to receive care under the plan, effectively offset reduced volumes and utilization during the pandemic.

One example is Kaiser Permanente, a Tier 1 system. During the pandemic, Kaiser returned $500 million in CARES Act funding (2) due to its financial position and business model. The only exception: $11.8 million in CARES Act funding for Maui Health System, a not-for-profit subsidiary of Kaiser (3). Even as the system posted a $1.1 billion loss in Q2 2020—primarily due to non-operating investment losses (4)—health system leaders were confident the system would bounce back. “Because Kaiser Permanente relies on prepayment rather than fee-for-service reimbursement, our model has allowed us to maintain revenue flow through the first wave of this pandemic,” Kaiser said in a statement (5).

As healthcare reimbursement transitions to a value-based model and the industry experiences rapid care delivery transformation and the continued impact of the COVID-19 pandemic, it’s crucial to evaluate models that address these challenges. A PSHP or capitated contract can hedge against volume losses and keep margins steady. We believe systems with these capabilities will be better positioned to withstand changes in volumes.

The views expressed by the authors are not necessarily those of H2C Securities Inc. and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by H2C Securities Inc. or any of its subsidiaries or affiliates, including but not limited to Fifth Third Bank, National Association, and are provided without any warranty whatsoever. Deposit and credit products provided by Fifth Third Bank, National Association, Member FDIC.

Footnotes

1. Daly, R., “Hospitals with Health Plans Have Gotten a Financial Boost During the Pandemic,” HFMA News, July 24, 2020.

2. Ellison, A., “Kaiser Returns $500M in CARES Act payments,” Becker’s Hospital Review, June 30, 2020.

3. Press Release, “CARES Act Funding and Kaiser Permanente,” Kaiser Permanente, https://wa-business.kaiserpermanente.org/kaiser-permanente-cares-act-funding/

4. Ellison, A., “Kaiser Returns $500M in CARES Act payments,” Becker’s Hospital Review, June 30, 2020.

5. Press Release, “CARES Act Funding and Kaiser Permanente,” Kaiser Permanente, https://wa-business.kaiserpermanente.org/kaiser-permanente-cares-act-funding/

H2C’s analysis highlights that the membership-based structure of a health plan provides a reliable stream of revenue, and when combined with lower costs when members elect not to receive care under the plan, effectively offset reduced volumes and utilization during the pandemic.

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Matthew T. Tarpley

Vice President

212.257.4516

mtarpley@h2c.com