"Hospital finances have been highly pressured and, in large part, driven up due to these increases in expenses, but a large part is on the labor side," says Eric Swanson, senior vice president of data and analytics at Kaufman Hall.

The pandemic has exacerbated the nationwide shortage of healthcare workers, and with hospitals and health systems' increasingly relying on contract labor their expenses are spiking, and profit margins are falling.

If hospitals and health systems hope to maintain their financial well-being, they'll need to find some out-of-the-box solutions that will reduce their dependency on contract labor, without sacrificing patient care.

According to new data from healthcare consulting firm Kaufman Hall, the rise in contract labor from 2019 through March of 2022 resulted in a 37% increase in labor expenses per patient. That's $4,009 to $5,494 per adjusted discharge. In hospitals and health systems, contract labor has grown from only 2% of total labor expenses in 2019 to 11% in 2022. Additionally, the hourly wage rate for contract nurses has skyrocketed by 106% from 2019 to 2022. According to Kaufman Hall, contract nurses are earning an average of $132 an hour in 2022 versus $64 in 2019. Wages for employed nurses for the same period have increased by 11%.

"In the beginning of this year, hospital finances have been highly pressured and, in large part, driven up due to these increases in expenses, but a large part is on the labor side," says Eric Swanson, senior vice president of data and analytics at Kaufman Hall. "There's extreme levels of growth here. We looked at some of the drivers of that labor expense growth, in large part, a lot of it is due to this growth in contract nursing. We noticed that not only had the amount of utilization of that contract labor increased—in some cases nearly five times the rate of utilization that it was before—but the payments that those hospitals are paying for these types of services have also increased nearly threefold."

There's been a supply and demand problem in the labor force since before the pandemic

A lot of the blame for the struggles currently facing the healthcare industry can be placed on the pandemic, but even before the crisis struck there was a shortage of nursing labor. Indeed, according to a 2018 reevaluation of registered nurse supply and demand from 2016 to 2030, there was expected to be a shortage of 154,018 nurses by 2020 and 510,394 nurses by 2030, according to the United States Registered Nurse Workforce Report Card and Shortage Forecast: A Revisit. When COVID-19 swept across the country, the labor shortage issue was exacerbated exponentially.

"As a result of that, one of the challenges that organizations faced was omicron," Swanson says. "As omicron hospitalizations increased dramatically, over a month-and-a-half period, the amount of nursing resources required to care for the patients coming into hospital were often not met by those that were employed by these systems. As such, they had to look elsewhere for resources to help handle this surge."

Hospitals and health systems will need to address the continuing labor shortage if they hope to remain financially stable and provide high-quality patient care. And there are actionable and creative steps hospitals and health systems can take to improve their financial health without cutting their workforce or reducing care quality, says Therese Fitzpatrick, PhD, RN, senior vice president of Kaufman Hall and a member of the firm's strategic and financial planning practice.

"We're seeing lots of creative things happening both on the supply and demand side," Fitzpatrick says. "On the demand side, it is the rare organization that is not looking at changing what their model of care looks like. Irrespective of the cause, with fewer RNs coming into the organization, hospitals all over the country are looking at their models of care. They're looking at team-based care, which is where a nurse, instead of necessarily doing that direct care system herself, is leading a team of licensed practical nurses and technicians who can deliver care. We're seeing a lot of that happening."

Embracing technology is a clear solution

Another thing Fitzpatrick says they've been seeing is the turn toward the digital facilitation of care, one example being an EICU center for patients. That means having a group of intensivists and nurses monitoring all the patients in ICUs for a large system.

"Instead of having those techs overlooking what's going on in each individual hospital, you can pull all of that monitoring into a central location," she says. "In a large system, let's say of a dozen hospitals, you can set up an electronic ICU to oversee what's going on in each of the critical care units in those hospitals. That allows you to better leverage physicians and nurses. So, we're seeing lots of that happening."

Retaining nursing and other staff is another challenge hospitals and health systems have been facing. As COVID-19 left its mark on the labor force, opening hospitals and health systems up to more competition from organizations in different industries, Kaufman Hall cites data showing one-in-five healthcare workers quit their job during the pandemic, and over a third of nurses plan to leave their current positions by the end of this year.

"We're also seeing some creative things happening with the recalibration of salaries," Fitzpatrick says. "We're not speaking just in terms of dollars, but in benefits as well."

Fitzpatrick says they are seeing organizations add benefits like childcare support and transportation subsidies to help create incentives for employees to stay and reduce their need for contract labor.

"Again, looking at both the supply and demand, and the creative strategies around recruitment and retention, [hospitals and health systems are] making meaningful changes to the work environment to retain that staff," she adds. "With federal subsidies winding down, we'll see a decrease over time in the use of contract labor, because hospitals don't have the money to be able to afford that."

The hospital system has expanded its presence in some rural areas, so patients don't have to drive for hours to receive specialized care.

Centura Health—an organization with 6,000 physicians, and $5 billion in net patient revenue—has made its first acquisitions in about seven years, adding two more hospitals to its healthcare system.

The acquisitions of St. Elizabeth Hospital in Fort Morgan, Colorado, and St. Catherine Hospital in Dodge City, Kansas, were completed on May 1, 2022, and closed for $135 million. The integration of these two organizations into the Centura Health system is part of the organization's plan to build a strongly connected system of hospitals in rural communities.

"When we developed our strategic plan, we realized about two-thirds of our growth is in existing markets and building up services programs—we're building two hospitals in geographies that we don't currently have a presence in," says Peter Banko, CEO of Centura Health. "Then we identified about a third of our growth—going from a $3.5 dollar system to a $7 billion system—we identified about a billion dollars in growth through acquisitions."

Once Centura Health realized this, it started to look at potential partnerships in Colorado, western Kansas, and northern New Mexico—all rural areas that have trouble attracting cardiologists, orthopedists, and other specialty physicians.

"Right now, patients at our hospital in Garden City, Kansas, have to drive two-and-a-half hours away to Wichita for specialized care," Banko says. "The same is true in Dodge City, and we've used Dodge City to start to get scale in that market and start to build up specialty care so that people in those communities don't have to drive [far] for specialty care. We'd love to have one more similar size acquisition in western Kansas. That would give us a population base of a little over 100,000 and we could keep care local."

Hospitals in small rural communities have been hit hard by the COVID-19 pandemic, with the Center for Healthcare Quality and Payment Reform estimating that 200 of these facilities are in danger of closing in the next two to three years. However, Banko says that Centura Health has been able to weather this storm thanks to supportive resources and financial operating discipline.

"We worked hard on associated physician engagement, quality, safety experience, being a high-reliability organization, and that served us well through the pandemic," he says. "We've taken some financial hits, like other organizations. The last three or four months have not been great for us. But our quality and safety improved, and our associate engagement is in the 75th percentile. Our financial performance, while weaker than it was the last four months, is stronger than most systems in the country, and we didn't see the declines that others did."

Despite that weaker than usual financial performance, Centura Health doesn't plan to give up on expanding its system through acquisitions and by building new hospitals.  

"Rural communities have suffered," Banko says. "Systems like ours can help support them with the scale that they need to be able to keep care local. So, we view the rural healthcare market as very attractive."

In general, hospital M&A activity has been on a downswing, according to data from Kaufman Hall. There were 34 announced hospital transactions in 2021, down from 62 in 2020, which was a decline from 71 in 2019. The decline in hospital and health system M&A activity can be attributed to fewer independent, unaffiliated community hospitals looking for partnerships, says Kaufman Hall. Organizations are also becoming more selective in the deals they are seeking, wanting partners who are making an impact through new technology, who have enhanced intellectual capital, and have access to new markets.

"The pandemic has focused new attention on issues of health equity and underserved populations, and addressing these issues is becoming a stated partnership goal," writes Anu Singh, managing director of partnerships and the M&A practice leader with Kaufman Hall. "This trend is also evident in the growing number of partnerships between health systems and specialized behavioral, home health, and other non-acute providers … as health systems work to address the needs of populations affected by the social isolation and other adverse impacts of the pandemic."

The healthcare landscape has been irreversibly altered over the last two years and this change has forced hospitals and health systems to reevaluate how they can best integrate the needs of the patients with their own financial needs.

As for Centura Health, the system is currently in talks with several potential partners about acquisitions over the next few years, but Banko didn't offer more detail than that.

"M&A is an interesting game," he says. "If you look at some national stats, about 70% of them fail. We're intentional about making sure we find organizations that share our mission, values, and vision, and that they see the future the same way we do. We put a lot of effort not just into the deal, but into the integration of the organization into the system. A lot of people do M&A and don't get it right, but I think we've figured out how to do it right."

Despite a rough financial start to the year, Kaiser Permanente says its overall operating performance is strong.

Kaiser Permanente has been feeling the effects of COVID-19 as its most recent financial report shows the California-based health system has been bombarded with expenses related to the ongoing crisis and the labor shortage.

According to the earnings report, in the first quarter of 2022, a rise in COVID-19 cases resulted in an additional $1.4 billion in expenses for Kaiser Permanente. Total operating expenses jumped year-over-year to $24.3 billion from $22.2 billion. Kaiser also reported a net loss of $961 million, versus a net income of $2 billion for the same period in 2021.

During the first quarter of 2022 Kaiser said it dealt with the steepest surge in COVID-19 cases since the onset of the pandemic which led to an increase in demand for care and testing. The organization also had an increase in expenses related to caring for patients who had put off seeking certain treatments at the height of the pandemic, the report said.

Despite the bleak start to the year, Kaiser Permanente executives are maintaining a positive outlook for the future.

"While the increase in pandemic-related expenses, overall rising costs, and investment market losses impacted our finances this quarter, Kaiser Permanente navigated this challenging time by providing high-quality care and continued investing in our integrated model including ongoing capital investments to best serve our members," Kathy Lancaster, executive vice president and CFO, with Kaiser said in the earnings release.

"As we face the ongoing uncertainty and prolonged effects the pandemic is having on the health care industry, we are well-positioned to continue delivering high-quality, affordable care and remain vigilant stewards of resources entrusted to us in this dynamic environment,” Lancaster said.

During the first quarter, Lancaster says the organization was able to maintain control over its discretionary spending while also caring for over 688,000 COVID-19 patients and addressing its backlog of surgical procedures. CEO Greg Adams shares Lancaster’s optimism for the future.

"While in the first quarter, the ongoing effects of the pandemic strained our workforce, communities, and operations, our operating model, which provides both care and coverage, enabled us to continue providing that care even in the face of an unprecedented omicron surge and industrywide labor shortage," Adams said. "Our underlying operating performance remains solid and aligned with expectations."

Some small rural hospitals are in danger of closing within the next two to three years.

Rural hospitals across the country are in danger of shutting down due to continuing financial losses on the delivery of services to patients and the end of the government-provided pandemic assistance, according to a new study from the Center for Healthcare Quality and Payment Reform (CHQPR).

Out of 600 rural hospitals, 200 are in danger of closing in the next two to three years, according to the CHQPR survey, while 30% of those 600 facilities are at risk of closing in the future. The increasing cost of delivering patient services rose due to the higher price of personal protective equipment and other expenses incurred due to COVID-19. At least one rural hospital in each state is at risk for "immediate closure," according to the CHQPR report, and in 16 states that figure jumps to five or more.

However, CHQPR says there are solutions to this problem, just not the ones that are most often put forward.

"Creating global hospital budgets, eliminating federal sequestration, eliminating inpatient services, and expanding Medicaid will not solve the serious problems facing rural hospitals," Harold Miller, president, and CEO of CHQPR said in the study. "The only way to ensure that residents of small rural communities have access to affordable high-quality healthcare is for their health insurance plans to pay adequately for the services delivered by their local hospitals. Rapid action is needed if we are going to prevent more hospital closures from occurring."

The CHQPR study suggests the best way to ensure rural communities can access affordable, high-quality healthcare is for health insurance plans to provide hospitals with standby capacity payments that will assist in maintaining the hospitals' ability to provide essential services. The CHQPR says payers will also need to adjust the way they pay small rural hospitals because most of the time they are underpaying these facilities. However, the biggest change is going to need to come from private health insurance companies. The low payments from private insurance plans and Medicare are the largest factor in small rural hospitals' negative margins.

"There are two different types of hospitals in America—large hospitals that make high profits on patients with private insurance, and small rural hospitals that lose money providing care to these patients," Miller said. "Private insurers are paying too much for services at many large hospitals but they are paying too little to sustain essential services in rural areas. Failure to address this will worsen healthcare disparities in the country."