Ongoing uncertainty is affecting every sector of the U.S. economy, and the healthcare industry is facing particularly daunting challenges as it looks for ways to mitigate risk and manage costs. However, as much as the current landscape presents challenges for healthcare companies, it also offers opportunity for future stability through strategic growth, according to Gyasi Chisley, managing director and head of the Corporate Healthcare for PNC Bank.
“Healthcare is the largest sector within our nation’s economy, and we’re at a unique moment in its history,” said Chisley. “In order to thrive through these economic headwinds and emerge stronger on the other side, it’s important that healthcare entities take a forward-looking approach and embrace new ways of managing their organizations, avoiding the temptation to react to symptoms of the macroeconomic forces like staffing and rather solve for the larger issues plaguing the entire healthcare ecosystem like flaws in the care delivery model itself.”
The Macroeconomic Backdrop
Sharp monetary policy shifts on the part of the Federal Reserve, combined with the lingering effects of the COVID-19 pandemic, have contributed significantly to the healthcare industry’s struggles. Quantitative easing, a monetary policy predicated on increasing the supply of and access to money, persisted since the economic crash in 2008. In 2015, the Federal Reserve slowly began to raise interest rates. This effort came to a sudden halt in March of 2020 with the onset of the pandemic, which sent the economy into a tailspin and prompted massive spending from the government in the form of stimulus programs. Estimates show that the U.S. government spent approximately $4.2 trillion on stimulus programs from 2020 through 2022, an amount that nearly matches the $4.3 trillion in annual spend within the healthcare industry. This stimulus spending, combined with the renewed implementation of quantitative easing and other factors, contributed to pushing inflation to record high levels.
To combat high inflationary rates, in 2022 the Fed reversed its course on monetary policy, taking a quantitative tightening approach and instituting a series of interest rate hikes. In the 17 months since March of 2022, the Fed increased interest rates ten times, starting at a Federal Funds Target Range of 0.00-0.25% and reaching a current target range of 5.00-5.25%, totaling 500 basis points in rate hikes during this time period. The current rate increase marks the highest hike in history from a starting point of 0.00%.
The Financial Services and Healthcare Industry Comparisons
The sharp shift to a tight monetary policy has had an adverse impact on both the healthcare and financial services industries in several similar ways. Many entities, within both sectors, that either lack significant market share or rely on narrow business models and cannot diversify risk, are now facing challenges as a result of the changing landscape.
Financial services and healthcare companies are both subject to stringent federal and state legislation along with regulatory oversight. The scrutiny has increased following the pandemic and the turn to quantitative tightening. While banks contend with added regulatory obligations through stress testing and liquidity coverage ratios, the Centers for Medicare and Medicaid Services (CMS) as well as healthcare insurers, are imposing higher standards on quality metrics for providers to maintain their Medicare license and achieve “value-based care” (VBC).
The financial services and healthcare sectors have also realized a consumer sentiment to seek stability via a “flight to quality”, transacting mainly with known brands within each industry. While this trend has led to a heightened level of consumerism and patient engagement, it also portends further consolidation in the markets and some diversification within major brands in both industries.
Health System Mergers and Acquisitions
Within the healthcare industry, consolidation is frequently taking place through mergers and acquisitions. Many health systems are merging out of necessity for efficiency and the need for scale. Moreover, some large health systems in disparate geographies are merging or acquiring hospitals outside their primary service areas, which can help them attain more leverage with healthcare insurers, create greater scaling opportunities in markets that may have more growth potential, and achieve VBC metrics. This phenomenon not only builds healthcare brands, but demonstrates to consumers, patients, and insurers that quality is paramount within their strategies.
Still, some smaller and regional hospitals that may lack significant market share within their primary service areas are working to become acquired, significantly eliminating services to focus on one specific specialty, or closing altogether. The market is also creating unlikely alliances, with former competitors in metropolitan service areas that are joining forces.
As COVID-19 reshaped business practices over the last three years, the presence of private equity has significantly penetrated the healthcare ecosystem. For investors and those leading private capital efforts within healthcare, the more calculated risk strategies and rising capital costs are resulting in lower valuations for start-up companies, longer transaction cycles, longer time between exit events, fewer investments being made per annum, and more availability of funds for the larger firms within the industry.
These occurrences have manifested in opening the door for new entrants, dubbed as disruptors, to enter the healthcare arena. Disruptors within retail, technology, and big data are all impacting the healthcare ecosystem and the way in which care is delivered. Many of these disruptors share similar characteristics, including high liquidity, a broad national or even international scale, and are diversified members of the Fortune 500 catalogue.
The Trend Toward Technology
Technology is playing a role in helping healthcare providers develop new revenue streams in the form of automated, customer-centric portals and platforms. For healthcare, digitization endeavors began before the pandemic, but accelerated during the pandemic because it was an essential tool to stay connected to patients. For example, telehealth usage rates increased 15 times among Medicaid recipients and Medicare beneficiaries between 2020 and 2022. While utilization rates have now returned to pre-pandemic levels, many healthcare entities have invested in platforms surrounding digital and device companies that shift the site of service away from traditional hospital settings, which may lead to revamped care delivery models over time incorporating artificial intelligence, geo-fencing, and other data sources.
An Outlook of Challenges and Opportunities
Even as the healthcare industry continues to evolve, rating agencies have downgraded non-profit healthcare to a negative outlook and are neutral about its future from a for-profit perspective. The healthcare industry is one of few sectors that cannot easily pass rising costs, due to inflation, back to the consumer or patient. Consequently, providers usually end up absorbing the higher costs. Additionally, providers often have difficulty raising costs for procedures or renegotiating terms with insurers due to contractual obligations and set fee schedules within contractual terms and provisions.
Despite the challenged outlook, as well as an anticipated push for increased regulation, PNC Healthcare perceives reasons for optimism. “The healthcare industry is facing challenges in the current economic environment, but it’s also evolving,” said Chisley. “Disruptors are instigating changes that are transforming the industry. Technology is streamlining healthcare delivery models, and that trend is only going to continue. So, the key questions for the industry are, how and when will healthcare entities pivot toward this transformation?”
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