Hospitals and health systems are facing significant financial and operational challenges, including inadequate reimbursements, rising labor costs, and regulatory and economic uncertainties. These hurdles, coupled with the One Big Beautiful Bill Act (OBBBA or the Act), create the potential for government actions aimed at cutting Medicare and Medicaid spending to increase the risk of hospital closures, particularly rural and safety net hospitals. Our webinar detailed the current healthcare financial distress landscape, explored potential options, and highlighted early planning strategies to improve long-term sustainability.
In Depth
The current financial distress landscape
Rural and safety net hospitals are at a heightened risk of closure. The financial strain is particularly pronounced among certain organizations, which often serve a high percentage of Medicaid, Medicare, and uninsured patients. Many industry publications have reported that more than 700 rural hospitals are at potential risk and, of those, more than 300 are at immediate risk. These facilities are facing tightened liquidity caused by the financial and operational challenges listed below, making it difficult to meet financial obligations such as paying debt service, vendors, or even payroll.
Key financial and operational challenges
- Labor and other operating costs have significantly increased, especially during the COVID-19 pandemic. While the rate of increase has slowed, the impact remains substantial and lasting. Some facilities often must pay more to attract and retain staff because of smaller labor pools, exacerbating their financial challenges. Additionally, the aging of the healthcare provider labor force and increased number of retirements has negatively impacted the size of the labor pool, resulting in upward pressure on wages and reduced access to care. Further, the high level of inflation and recently implemented tariffs will continue to have a significant impact on supplies and other operating costs.
- Reimbursement rate increases from the Centers for Medicare & Medicaid Services (CMS) and other payors are not keeping up with the rising cost of care, causing operating margin deterioration and challenges meeting capital investment requirements.
- OBBBA contemplates sweeping Medicaid eligibility requirements and a reduction in federal funding for states, among other changes, all of which will negatively impact hospitals and exacerbate the challenges healthcare providers are already facing. These uncertainties can lead to delays in strategic decisions and mergers and acquisitions deals, as decision-makers need clarity to plan effectively.
The importance of early planning and action
Detection and a realistic assessment of the distressed situation and related ramifications are critical for creating an opportunity to navigate a potential solution or mitigate the negative impacts. Planning ahead and taking steps to address financial distress early can lead to substantially better results for hospitals and health systems and the communities they serve. Early planning allows hospitals to evaluate their financial situation, consider various strategies, implement cost savings initiatives, identify liquidity needs, and potentially negotiate better terms for transactions or reorganizations.
Without early detection and planning, hospitals may face increased costs, reduced options, and a higher risk of closure, which can have a significant impact on the community, especially in rural areas where hospitals are often the largest employers and provide essential access to healthcare. The uncertainty surrounding Medicaid cuts, tariffs, and rising operating costs can paralyze decision-making. Therefore, addressing financial distress and taking measured action as soon as possible can help hospitals address these challenges more effectively. Strategies for navigating financial distress include:
- Implementing cost reduction and cash conservation initiatives, improving revenue cycle management (including coding and documentation), and eliminating unprofitable services may be necessary to extend the liquidity runway and enable a hospital to achieve stabilization. However, there is a balance to be mindful of to preserve clinical services to remain an attractive partner for a future affiliation or merger with a larger system.
- Forming affiliations and partnerships with larger health systems can provide financial stability and operational support. Larger systems can offer economies of scale, shared resources, and better negotiating leverage with vendors and payors. However, the current economic uncertainty and reduced capital expenditure budgets have made it harder for these deals to materialize. Implementing immediate cost reductions and identifying performance improvement opportunities may make an organization a more attractive affiliation or merger partner.
- For hospitals that qualify, converting to a rural emergency hospital (REH) is a potential solution. This model can reduce financial burden by focusing resources on essential emergency care, which is often the most critical service in rural areas. However, the conversion process requires careful planning and regulatory approval.
- To attempt to mitigate the substantial impact of the OBBBA Medicaid cuts on the healthcare industry, the Act incorporates the Rural Health Transformation Program, which will allot $10 billion to states for each fiscal year from 2026 to 2030, for a total of $50 billion for the five years. States must apply to receive funds from the program, and rural health providers will need to be proactive and coordinate with the state to obtain funding. For each of the fiscal years, 50% of program funds will be equally divided among the 50 states, but CMS will have substantial discretion as to the amount each state receives from the other 50%.
- Hospitals may use chapter 11 bankruptcy to reorganize and address financial distress. It provides a structured process to fix issues, leave behind debt, and reject unfavorable contracts. It can also increase the value of a sales process because it allows a buyer to pick which assets it wishes to purchase and leave behind certain liabilities. While bankruptcy can be an effective solution, it is an expensive and complex process that can have uncertain outcomes. Early planning and negotiation can lead to more favorable results. Prepackaged bankruptcy sales, where agreements are entered into before filing, can help streamline the process and minimize disruption while allowing hospitals to evaluate their financial situation, consider various strategies, and potentially negotiate better terms for transactions or reorganizations.
As noted during the webinar, these financial challenges paradoxically create opportunities for better-situated hospitals and health systems to pursue growth strategies while challenged rural and safety net hospitals may need to wind down and close.
Regulatory and transaction considerations
- Hospitals and health systems face regulatory and antitrust hurdles that can complicate their restructuring efforts. Antitrust concerns can arise when multiple hospitals in the same community consider merging or affiliating, leading to regulatory scrutiny and a challenging approval process. The failing firm exception in antitrust law can be helpful, but it requires clear evidence of financial distress and a lack of another suitor.
Regulatory and operational wind-down considerations
- Closing a hospital involves multiple regulatory hurdles, including licensure issues and state approvals. Health systems must coordinate with various stakeholders and be prepared for public scrutiny and the likelihood of negative public relations. Different states also have varying regulatory and approval requirements for hospital closures, which can complicate the process, extend the time before action on the closure plan is authorized, and exhaust the limited resources needed to effectuate a wind down and closure. Government and elected officials may also attempt to intervene, formally or informally, risking additional delays. Having a carefully crafted communication plan is essential to the wind down and closure process.
- Hospitals should pay close attention to the post-closure management of medical records, accounts receivable, employee and provider records, hazardous materials, the disposition of equipment and supplies, and security and maintenance of facilities. Ensuring compliance with all legal and regulatory requirements is crucial to avoid additional issues and maintain the trust of the community.
Conclusion
Navigating financial distress in the healthcare sector requires a multifaceted, proactive approach. Hospitals and health systems can stay ahead of the curve by evaluating their financial health, exploring strategic partnerships, and understanding the regulatory landscape. Timely and transparent communication with regulators and stakeholders can maximize restructuring options and facilitate smoother transitions. By proactively addressing financial issues, hospitals enhance their chances of long-term sustainability and continued service to their communities.
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