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Hospital of the Future

Systems of Health: A Strategic Perspective

Hospitals are the centerpiece of health services in every community. However, the future for most hospitals is uncertain. Declining demand for inpatient care is countered by explosive demand for services in outpatient and in-home settings. As hospitals consider their market conditions, competition, resources, and appetite for risk, evolution into one of three destinations is likely:

  1. Medical Center
  2. Integrated Delivery System
  3. Integrated System of Health

Evaluating each systematically with an objective view of the future is necessary to a hospital’s long-term viability.

Market conditions, resources, and an organization’s appetite for risk vary. There is no easy path for any hospital.

Background

Hospitals have played a central role in the evolution of the U.S. health system since the founding of America’s first hospitals: Bellevue Hospital in 1736, Pennsylvania Hospital in 1752, New York Hospital in 1771, and Massachusetts General Hospital in 1811. Today, nearly 6,200 hospitals provide inpatient, outpatient, ancillary, and care management services in urban, suburban, and rural settings.

Along the way, hospitals have adapted to trends that challenge their viability:

  • Exponential expansion of clinical evidence
  • Widening demand from episodic to chronic health problems
  • Competition from private investor-backed niche providers
  • Technologies that disrupt how services are delivered and by whom
  • Consumer expectations and increased regulatory scrutiny
St Lukes Hospital

Hospitals arguably represent the most prominent sector in U.S. healthcare, accounting for 31 percent ($1.2 trillion) of total healthcare spending as of 2019, employing 290,000 physicians and 6.6 million support staff. In most communities, it is the epicenter for healthcare programs that serve the entire population.

Trends and Assumptions That Impact Hospitals

In the U.S., demand for healthcare services is exploding as the population ages, but operating margins in hospitals are under pressure as the coronavirus and operating costs take their toll. Five trends have prompted hospitals to reassess their long-term strategies:

  1. Declining demand for inpatient services: The core business for most hospitals is inpatient care. Yet, demand for inpatient care has declined 10 percent (from 38.2 million to 35.8 million patient days) over the past decade as clinical innovations expand outpatient and home-based service delivery. Those needing inpatient care today are older, sicker, and more expensive to treat.

  2. Increased costs for drugs, supplies, technology, facilities and labor, as well as indirect costs for administration and compliance: Hospital costs are expected to increase 6.8 percent this year, which is the result of inflation in the cost of drugs, technology, facilities, and labor (it was 6.7 percent in 2019). At the same time, reimbursement from Medicare, Medicaid, and private insurers has shrunk, resulting in 2020 operating margins of less than 2 percent, which includes temporary COVID-19 relief funding.
  3. Increased enrollment in government insurance programs (Medicare, Medicaid, etc.) that reimburse hospitals at less than their costs: The combined enrollment in Medicare and Medicaid is 127 million (61 million in Medicare and 66.9 million in Medicaid). Both programs are growing, and neither reimburses hospitals at rates that cover their direct and indirect costs. In response, hospitals charge individuals and employers more: per RAND, private payers pay 247 percent of the average Medicare reimbursement rate and up to 400 percent in some markets. All agree this is unsustainable for private payers. There is pressure on hospitals to reduce costs aggressively concurrent with continued government cuts in Medicaid and Medicare reimbursement.
  4. Increased consolidation among hospitals to maintain their viability: The horizontal consolidation of hospitals into health systems grew modestly between 2016 and 2018 from 70 percent in 2016 to 72 percent in 2018. Today, 91 percent of hospital beds are in system-affiliated hospitals, which is an increase from 88 percent in 2016. Yet, studies show horizontal consolidation has not resulted in lower hospital costs. The consolidation of hospitals into multihospital systems has changed the competitive landscape for local hospitals, unsettled relationships with local physicians, and prompted aggressive contracting negotiations by insurers.
CVS pharmacy website highlight
  1. Increased competition from nontraditional providers: The availability of investment capital and attractive market opportunities in healthcare for strategic investors has sparked massive investments by private equity in hospitals, medical practices, and a wide range of delivery programs. Strategic players like United, CVS Aetna, Humana, Walmart, Amazon, and others see the industry as a ‘platform play’ to change how care is delivered and financed. Private equity-backed physician organizations such as ChenMed, Iora, Oak Health, Privia, and others see opportunities to disintermediate physicians from local hospital relationships and capture revenue. Hospitals are at a disadvantage, especially during the pandemic.

Looking forward, eight assumptions about the future must be informed by hard data and immune to unnecessary risks. Hospitals have little margin for error. There is much at stake. With that in mind, hospitals of the future are rethinking their strategies according to the following:

Healthcare will advance despite the pandemic: While vaccines by Pfizer, Moderna, Astra Zeneca, and others will continue being approved and administered, we will continue dealing with the pandemic and its variants for some time.

  1. Demand will accelerate for outpatient, office-based, and in-home health services: The aging of the population, the prevalence of chronic disease, and the expanded role of technology-enabled health will sustain long-term volume growth.
  2. Federal health policy changes will shift toward access and affordability: Increased insurance coverage for the under-insured and uninsured, increased pressure on drug prices, intensified scrutiny of hospital consolidation, and the declining reimbursement for hospitals and specialists are the likely focus of health policy changes. There will also be a focus on access and affordability in urban, underserved, and minority communities. To further address widespread disparities and public health, pursuing Medicaid expansion is also expected.
  1. Competition will intensify: Healthcare is a growth market, which is expected to increase from 18 percent of the GDP today to 21 percent by 2028. Vertically integrated systems will strengthen their relative advantage.
  2. Health and wellbeing will be a major emphasis: Consumers are increasingly conscious and responsive to social determinants of their health.
  3. Private investors will play a bigger role in financing the capital requirements of the health system: Private investment represents 45 percent of capital in-flow to healthcare. Last year, there were 29 IPOs and 315 private equity deals in health services. For the foreseeable future, private investment in healthcare will grow and its negative impact on local hospital competitiveness will intensify.
Doctor speaking with medical staff
  1. Employer-sponsored health insurance and benefits will shrink: Employer-sponsored health benefits cover 160 million Americans and provide 80 percent of hospital operating margins. Given current regulations and rising costs, employers will implement aggressive strategies to serve the needs of their workforce (i.e. direct contracting, carve-outs, reference pricing and on-site/near-site primary care clinics). Their employees will assume greater financial responsibility for the providers and methods of care they use.
  2. Vertically integrated systems of health that operate at scale will capture a greater share of the healthcare market long-term: Scale and scope are keys to long-term hospital sustainability and growth. The ability to deliver and finance healthcare programs for targeted populations vis a vis fully capitated payment arrangements will be imperative. Inpatient care will be a cost center.

The net impact of these changes is continued growth in healthcare spending, averaging 5.4 percent annually through 2026. Increases in hospital and drug costs will drive escalation and attract competitors who offer guaranteed improvements in efficiency (costs), access (facilities and digital connectivity), and effectiveness (outcomes and safety).

The Three Major Destinations for Hospitals

Market conditions, resources, and an organization’s appetite for risk vary. There is no easy path for any hospital. For most, three destinations are possibilities:

hospital icon

Destination One:

Hospital/Medical Center

A hospital/medical center is a comprehensive provider of choice for inpatient, outpatient, and ancillary services in a local market/community where market growth characteristics are favorable and demand for expanded scale of provider services exists.

For many hospitals (e.g. safety-net hospitals, academic medical centers, sole community, providers in markets with stable population growth, and specialty hospitals), a primary focus on the acute portfolio is an appropriate strategy provided that:

  1. Hospitals are aligned with a strong clinically integrated physician organization
  2. Insurers and large employers engage through meaningful shared risk programs
  3. Hospitals/medical centers have adequate capital to offer a full range of competitive acute programs and ancillary services in ambulatory and home settings

The challenge for hospitals/medical centers is the gradual rebalance of specialty services with primary, preventive, and wellbeing services complemented by a comprehensive digital front door and modern hubs of community health activities and services.

hospital icon

Destination TWO:

Integrated Delivery System (IDS)

A comprehensive IDS offers hospital, physician, post-acute, and wellbeing services to a regional population deploying traditional and alternative therapeutic interventions.

Inpatient services are a vital element of the clinical portfolio. However, rationalization of capital and operational resources to drive high-volume inpatient specialty centers in targeted locations is a critical consideration. Clinical “product lines” are  comprehensive integrating diagnostics, treatments, and primary care services in every setting and management of patient experiences a key focus.

IDS is a strategic option for a hospital/medical center in a market where population growth might be slowing/aging and the system’s operating strategy permits it to break even on contracts with Medicare, Medicaid, and commercial insurers, but full/substantial recovery of payments risk from patients is unlikely. Alignment with a multispecialty physician organization, integrating post-acute capabilities (e.g. skilled nursing and home care), and adding retail health programs (e.g. clinics and self-care management) are key. An IDS requires effective allocation of capital deployment and management attention, plus competitive positioning for its clinical programs based on total-cost-of-care competitive advantages.

hospital icon

Destination THREE:

Integrated System of Health

An integrated system of health assumes full clinical and financial risk for contracted populations across multiple markets.

It includes all elements of an IDS, plus managed care through a joint venture with an insurer or self-sponsored plan for which the integrated system of health assumes full actuarial and capital risks. This option requires substantial capital and expanded capabilities: it is often implemented in tandem with a strategic business partner or collaborator.

Operating a health plan requires a unique set of operational capabilities (provider credentialing, medical management, claims adjudication, premium pricing, customer services for enrollees, etc.) and utilization management processes to ensure enrollee care is evidence-based and necessary.

Getting Started

Evaluating destinations for hospitals is an ongoing challenge: collecting data, analyzing opportunities and threats, and calculating risks are standard fare. In most organizations, these activities revolve around five key areas:

Critical Factor
Key Considerations
Hospital/Medical Center
Integrated Delivery System
Integrated System of Health
STRATEGIC FOCUS
Board and leadership aspirations:
Provide high quality, affordable, acute, outpatient, and physician services in a community
Provide high quality, acute, post acute, wellbeing, and preventive health services in a region
Provide comprehensive health services to a defined population for which the system assumes full financial risk for outcomes and costs
MARKET CONDITIONS
  • Population size and growth
  • Demography and health status
  • Relative market share
  • Payor opportunity
Opportunity to enhance and grow core hospital specialty services with sustainable funding
Opportunity to manage the health populations via shared risk arrangements with payers
Opportunity to finance and deliver comprehensive health services in a community/region
SCOPE OF SERVICES
  • Service portfolio
  • Facility-based (IP, OP, Office)
  • Retail
  • Home
  • Digital
Regional hospital and community benefit (SDOH focus)
Integrated delivery network, SDOH focus, and enhanced professional services network
Integrated Delivery Network and Sponsored/Partner Insurance Plan
SCALE OF SERVICES
  • Revenue
  • Capitalization/Assets
Less than $200 million
$200 million to $1 billion
$1 billion or more
RELATIONSHIPS
  • Physicians
  • Insurers
  • Consumers
  • Physicians
  • Payers
  • Patients
  • Private equity/strategic partners
  • System affiliates
  • Payers
  • Consumers
  • Physician organization
  • System affiliates
  • Payers
  • Consumers
  • Physician organization
  • Strategic partners

The Critical Path for Hospitals & Health Systems

Accelerators present in the industry today carry a different weight of influence that is unique to each system and its goals. They must be integrated or mitigated as a system moves through assessment in order to achieve the ideal state or “destination.”

Hospital of the Future infographic

ERDMAN Takeaway

For more information on how you can take a strategic approach to plan for your future hospital, ERDMAN is your resource for valuable insights.

  1. The American Hospital Association. (2021, January). Fast Facts on U.S. Hospitals, 2021. https://www.aha.org/statistics/fast-facts-us-hospitals
  2. Agency for Healthcare Research and Quality. (2017) Defining Health Systems. https://www.ahrq.gov/chsp/chsp-reports/resources-for-understanding-health-systems/defining-health-systems.html

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