hospital financial conditions - The Center for Rural …...Rural Hospital Financial Conditions 5...

Rural HospitalFinancial Conditions

These research projects were sponsored by grants from the Center for Rural Pennsylvania, a legislative agency ofthe Pennsylvania General Assembly.

The Center for Rural Pennsylvania is a bipartisan, bicameral legislative agency that serves as a resource for ruralpolicy within the Pennsylvania General Assembly. It was created in 1987 under Act 16, the Rural Revitalization Act,to promote and sustain the vitality of Pennsylvania’s rural and small communities.

Information contained in these reports does not necessarily reflect the views of individual board members or theCenter for Rural Pennsylvania. For more information, contact the Center for Rural Pennsylvania, 625 Forster St.,Room 902, Harrisburg, PA 17120, telephone (717) 787-9555, fax (717) 772-3587, email:[email protected].

Evaluating Financial Distressin Rural Pennsylvania Hospitals

byJohn M. Trussel, Ph.D., CPA, Pennsylvania State University–Harrisburg and

Patricia A. Patrick, Ph.D., CPA, CFE, CGFM, Shippensburg University of Pennsylvania

An Analysis of Rural Hospital Financial Conditions

Rural Hospital Financial Conditions

byJami DelliFraine, Ph.D, M.H.A., Lisa Davis, M.H.A., Harry Holt, J.D., M.B.A.,

and Larry Baronner, M.S., M.Ed., Pennsylvania State University

March 2010

4 The Center for Rural Pennsylvania

PrefaceRural hospitals are the healthcare backbone for many

rural Pennsylvania communities. In fact, almost 4million residents in Pennsylvania rely on rural hospitalsfor a variety of healthcare services.

Over the past few decades, however, many ruralhospitals have been facing challenging financial times.Some have been forced to close, while others havemerged with other hospitals, eliminated or reducedservices, or taken other actions to remain viable.

To take a more indepth look at the financial health ofrural hospitals in Pennsylvania, the Center for RuralPennsylvania sponsored two research projects related torural hospital finances in 2008.

The first research project was conducted by research-ers from Pennsylvania State University-Harrisburg andShippensburg University of Pennsylvania. The goal ofthe research was to develop a comprehensive model forevaluating financial distress in general acute carehospitals in rural Pennsylvania. The researchers devel-

Table of ContentsEvaluating Financial Distress in Rural Pennsylvania Hospitals


Executive Summary ...................................................................................................................................... 5Introduction .................................................................................................................................................... 6Goals and Objectives ..................................................................................................................................... 6Methodology .................................................................................................................................................. 7Results .......................................................................................................................................................... 12Conclusions .................................................................................................................................................. 19Policy Considerations .................................................................................................................................. 20References .................................................................................................................................................... 22Appendix A: Probability of Financial Distress (FD) for Rural Hospitals 1997-2006 ........................... 24Appendix B: Rural Hospitals Ranked by Probability of Financial Distress .......................................... 45

Executive Summary .................................................................................................................................... 47Introduction .................................................................................................................................................. 47Goals and Objectives ................................................................................................................................... 50Methodology ................................................................................................................................................ 50Results .......................................................................................................................................................... 51Conclusions .................................................................................................................................................. 62References .................................................................................................................................................... 64

oped the model primarily to predict financial distressand to provide early warning signals of distress todecision-makers.

The second project, conducted by researchers fromPennsylvania State University, examined the financialperformance of rural hospitals from a number ofperspectives, including profitability, liquidity, efficiencyand capital structure. According to the results, over thestudy period of 1997 to 2006, the financial health ofrural hospitals was tenuous; and critical access hospitalswere among the worst performing. Trends also indicatedthat increased competition, physician recruitment andretention, and providing care for patients who areelderly, underinsured or uninsured are negativelyimpacting rural hospital finances.

The methodologies and results of these researchprojects are presented in the following pages.

Copies of the individual reports are available bycontacting the Center for Rural Pennsylvania.

Rural Hospital Financial Conditions 5

Evaluating Financial Distress in Rural Pennsylvania HospitalsExecutive Summary

Pennsylvania’s rural hospitals play a critical role in thehealthcare of almost 4 million residents. For many ruralresidents, these hospitals are their only source ofhealthcare. This makes the financial viability of ruralhospitals critical to the health of many Pennsylvanians.

The purpose of this study was to develop a comprehen-sive model for evaluating financial distress in generalacute care hospitals in rural Pennsylvania. The primaryfocus was to predict financial distress and provide earlywarning signals of distress to decision-makers.

Financial distress is a condition that exists when ahospital is experiencing financial trouble that may forceit to close, merge with another hospital, declare bank-ruptcy, eliminate or reduce services, or take similaractions with adverse consequences to the healthcaredelivery system of a region.

This research determined the risk factors that areassociated with financial distress in hospitals and ana-lyzed the risk factors in five categories – structural,financial, patient mix, utilization, and market forces.Structural factors included a hospital’s rural or urbanstatus, size, teaching status, critical access status, profitstatus, and system status. Financial factors includedliquidity, solvency, charity care, and patient cost per day.Patient mix included Medicare, Medical Assistance andmanaged care, and reflects the type of reimbursementreceived for patient services. Utilization (a measure ofhow efficiently the hospital’s assets are employed)included length of stay, occupancy rate, and inpatientshare of net patient revenue. Market forces included theregional poverty rate, percentage of elderly personsserved, and hospital concentration or competition.

The researchers collected data to compute the riskfactors for all urban and rural for-profit and nonprofitgeneral acute care hospitals in Pennsylvania from 1997to 2006. The data were used to predict whether or not ahospital was financially distressed.

The results indicated that several of the risk factorswere significantly related to financial distress. Forexample, compared with other hospitals and controllingfor all of the other risk factors, an increased risk offinancial distress was found in hospitals with lower ratiosof current assets to current liabilities, lower ratios of cashflows to debt, lower costs per day, higher charity care,lower Medicare, Medicaid and managed care reimburse-ments, higher inpatient services (as opposed to outpatientservices), shorter lengths of stay, and lower occupancyrates.

An increased risk of financial distress was also foundin hospitals that operate in counties with higher poverty

rates, lower proportions of elderly patients, and highercompetition among hospitals.

Using these risk factors, the researchers were able toclassify the financial condition of 67 percent to 90percent of hospitals for the 10-year period analyzed. Theresults allow decision makers to not only predict finan-cial distress, but also evaluate the impact of a change in arisk factor on the likelihood of financial distress. Forexample, even a relatively small decrease in the amountof charity care provided by a hospital led to a significantdecrease in the likelihood of financial distress.

Perhaps the most interesting finding was that when theresearchers controlled for all risk factors, the rural statusof a hospital significantly reduced the likelihood offinancial distress. The researchers directly compared therisk factors of rural hospitals to urban hospitals. Ruralhospitals operated with higher cash flows to long-termdebt and lower costs per day, and operated in countieswith less competition and with larger proportions of theelderly. Rural hospitals also provided less charity andinpatient care. All of these factors were associated withlower financial distress.

However, rural hospitals also tended to have fewerbeds, less net patient revenues, lower ratios of currentassets to current liabilities, and lower occupancy rates.These factors were associated with higher financial distress.

Critical access status alone was not a predictor ofdistress, yet many of Pennsylvania’s critical accesshospitals operated with significant risk of financialdistress. In fact, 59 percent were financially distressedduring the study period. Critical access hospitals operatedwith fewer beds, had lower current ratios, had lower cashflows to long-term debt, and provided more charity care,all factors associated with higher financial distress.

Rural hospitals are vital to their communities, but onlyif they maintain their financial viability. Policy makerscan use the factors identified in this study as earlywarning signals of financial distress and the recommen-dations to reduce the likelihood of financial distress.

One consideration is for policy makers to designate acommonwealth agency to use the results of this study tomonitor the financial health of Pennsylvania’s ruralhospitals. This agency can provide support and assistanceto rural hospitals in a manner not unlike a small businessdevelopment center. Such an initiative would support theprogrammatic goals of the Pennsylvania Department ofHealth, which seeks to develop a network of support forrural hospitals, as well as those of the PennsylvaniaOffice of Rural Health, which administers the FlexProgram for critical access hospitals.


Introduction

Goals and ObjectivesThe first goal was to identify the risk factors of

financial distress in hospitals. Risk factors are indicators,such as financial ratios, that are associated with financialdistress. The objective of this goal was to identify aspecific set of risk factors associated with financialdistress in hospitals. The researchers identified severalmeasures of financial distress in five categories includingstructural, financial, patient mix, utilization, and marketfactors.

The second goal was to predict whether or not ahospital will become financially distressed. Using therisk factors from the first goal and two groups ofhospitals – financially distressed and not financiallydistressed – the researchers developed a predictive modelof financial distress. This analysis resulted in the prob-ability of a hospital becoming financially distressed,which allowed the researchers to predict the classificationas distressed or not distressed in advance. The probabilitywas determined by comparing the profiles of financiallydistressed hospitals to other hospitals. The objective ofthis goal was to determine the probability of financialdistress for each rural hospital in the sample.

The third goal was to use the risk factors identified inthe first goal to distinguish between hospitals that survivefinancial distress and those that do not. Financiallydistressed hospitals will eventually either fail (by closingor merging with another hospital) or survive (continue tooperate). The researchers used the risk factors developedin the first goal to determine if there was a differencebetween financially distressed hospitals that survive andthose that fail. The objective of this goal was to comparethe mean ranks of each risk factor for financially dis-tressed hospitals that survived and those that failed.

Rural hospitals nationwide face unique challenges.Wide distances and difficult terrain often separate ruralhospitals from their patients. Many of these hospitalsoperate in depressed areas, making them susceptible toeconomic and reimbursement changes (U.S. Senate,2000). Rural hospitals also often serve an elderly andlower income population. The problems of rural hospi-tals may have been exacerbated when Congress passed theBalanced Budget Act of 1997 (BBA) to balance the federaldeficit through Medicare reform (Bazzoli et. al, 2004/2005). Rural hospitals were hit hard, as a large portion oftheir patients rely on Medicare (U.S. Senate, 2000).

Pennsylvania’s hospitals were no exception. By 1999,80 percent of Pennsylvania’s hospitals were unable tocover their operating expenses through net patientrevenues (Pennsylvania Department of Health, 2000). By2001, 28 Pennsylvania hospitals had closed, althoughmany of these were not general acute care hospitals(Pennsylvania Health Care Cost Containment Council,2006). In 2006, 47 general acute care hospitals hadnegative operating margins in Pennsylvania. Of these, 18were rural, and three were critical access hospitals. Ruralhospitals are vital to their communities, but only if theyremain financially viable.

A U.S. Senate subcommittee on rural developmentsaid rural hospitals were hit harder by the BBA thanurban hospitals (U.S. Senate, 2000). Others agree withthis belief, including officials from the U.S. Departmentof Health and the Human Services’ Center for HealthPolicy Research and Ethics at George Mason University.While not all analysts agree that the BBA has put ruralhospitals at risk (Moyse, 2005), Younis (2003) foundrural hospitals to be less financially viable than theirurban counterparts. This seems to be especially true forrural hospitals that were already struggling (Bazolli, etal., 2006).

The purpose of this research, which was conducted in2008, was to develop models for evaluating the financialhealth of general acute care (GAC) hospitals in ruralPennsylvania. A GAC hospital is an institution thatmaintains and operates facilities for the purpose ofproviding a wide variety of diagnostic, treatment andsurgical services across multiple specialties. GAChospitals include for-profit and nonprofit hospitals,teaching hospitals, and specialty acute care hospitals,which include children’s and obstetric (OB/GYN)hospitals.

GAC hospitals exclude hospitals that are not accessibleto the general public, such as state and federally-ownedgovernment hospitals, prison hospitals, and collegeinfirmaries. They also exclude ambulatory services,psychiatric hospitals, and long-term care facilities, such

as rehabilitation hospitals and nursing homes, as patientstypically stay at GAC hospitals for less than 30 days.

The models developed by the research addressed threekey questions:

1. What are the risk factors associated with financialdistress in hospitals?

2. Can these risk factors predict whether a hospitalwill become financially distressed?

3. Can these risk factors distinguish between hospitalsthat survive and those that do not survive financialdistress?

State government, which establishes healthcare policy,plays a critical role in the financial health ofPennsylvania’s rural hospitals. The results of this re-search may enable policymakers and administrators tomake informed decisions about the structural, financial,patient mix, utilization, and market factors that affect thefinancial health of Pennsylvania’s rural hospitals.


Conceptually, a financially distressed hospital is onethat is experiencing financial problems that may force itto close, merge with another hospital, declare bank-ruptcy, eliminate services, or take other similar actionswith adverse consequences to the healthcare deliverysystem of a region.

The researchers defined a GAC hospital as financiallydistressed if it experienced three consecutive years ofnegative operating margins.

Data sourcesTo evaluate the financial distress of GAC hospitals in

rural Pennsylvania, the researchers gathered financial andnon-financial data from the GAC hospitals in Pennsylva-nia. The researchers used the Center for Rural Penn-sylvania’s rural county definition, as follows, to locaterural GAC hospitals: a county is considered rural if thenumber of persons per square mile within the county isless than 274.

Most of the financial and non-financial data came fromthe Pennsylvania Health Care Cost Containment Council(PHC4), which collects financial data from all Pennsyl-vania hospitals. All GAC hospital data included in thePHC4 database during any of the years from 1997 to2006 were used. The remainder of the data needed forthe research, such as the percentage of the countypopulation living in poverty, came from the U.S. CensusBureau. The researchers used 10 years of data to developthe statistical models. These data were merged across the10-year period to create cross-sectional longitudinal(panel) data.

Identifying the risk factors of financial distressin hospitals

The researchers used risk factors of financial distressbased primarily on those used in prior academic studiesand in practice (e.g., McCue, 1991). For example,Gapenski et al. (1993) separated 22 ratios into fourcategories, including organizational variables (size, typeownership, etc.), managerial variables (labor intensity,age of plant, cost management, strategic planning, etc.),patient mix variables (case mix, inpatient, outpatient,intensive care, etc.), and market variables (hospitalconcentration, physician density, patient income, etc.).Gapenski et al. separated their ratios into distinct catego-ries because they believed some categories are morecontrollable by management than others. They alsobelieved that organizational and market variables areonly somewhat controllable while managerial and patientmix factors are controllable. Separating the ratios intocategories based on degree of managerial control isuseful if distress is identified and administrators are

looking for ways to reduce it. This study used a similarformat.

This research analyzed risk factors in five categories –structural, financial, patient mix, utilization, and marketforces.

Structural factorsStructural factors are relatively uncontrollable, yet

potentially important predictors of financial distress.These factors include the hospital’s urban or rural status,the size of the hospital, teaching status, critical accessstatus, profit status, and system status.

Rural statusHospitals in rural communities face a variety of

structural differences, which may put them at a disadvan-tage compared with their urban counterparts. They tendto be smaller, have a lower volume of patients, have aharder time attracting and keeping qualified staff, andserve a different population. Rural hospitals often servecommunities with higher proportions of elderly, unin-sured and low-income patients and migrant workers(Younis and Forgione, 2005).

Like urban hospitals, rural hospitals must maintainexpensive facilities, but they often lack the capitalneeded to replace outdated equipment and make facilityimprovements. Exacerbating the problem is the Medicarereimbursement system, which has historically reimbursedrural hospitals at a lower rate than their urban counter-parts. By the late 1980s and early 1990s, rural hospitalswere in desperate financial condition. Their operatingmargins plummeted and they were closing in dispropor-tionate numbers. Responding to the crisis, President Bushsigned the Medicare Prescription Drug Improvement andModernization Act of 2003 (MMA) to broaden thedefinition of rural and improve the Medicare reimburse-ment scheme for rural hospitals (Moyse, 2005). SinceOctober 2004, rural hospitals have received a cost-plusMedicare reimbursement subsidy designed to preserverural residents’ access to healthcare (Freidman et al.,2004) and to help protect the hospitals from financialfailure (Moyse, 2005).

Despite these improvements, this study’s researchersbelieved rural hospitals operate in an environment thatexacerbates the risk of financial distress. Thus, theresearchers expected rural hospitals to be more vulner-able to financial distress than urban ones.

Hospital sizeLarger organizations are usually located in cosmopoli-

tan areas and have better access to resources, informa-tion, and employees. Organizational size is usuallycorrelated with reputation, economies of scale, andfinancial expertise. When speaking of hospitals, size is

Methodology


1 To control for highly skewed NPR figures, the researcherstransformed the NPR by taking the natural log of each figure (inNPR).

usually measured in terms of the number of inpatientbeds. Early research in hospital size showed the mostprofitable hospitals operating with 200 to 300 beds(Feldstein, 1998). Later research showed a curvedrelationship between profitability and size with theoptimum size at about 238 beds (Kim et al., 2002).

This study’s researchers used two proxies for size. Thefirst was the number of staffed beds (the number of bedsset up and staffed at the end of the hospital’s fiscal year).The other was net patient revenues (NPR).1 The research-ers expected that larger hospitals were less prone tofinancial distress.

Teaching statusTeaching status refers to whether or not the hospital is

affiliated with a nearby medical school. Teachinghospitals provide training for interns and residents. Theyalso treat high numbers of indigent populations withlittle to no compensation (Younis et al., 2001). Teachinghospitals tend to be large hospitals located in urban andeconomically-depressed areas (HCIA, 1997). They treatpatients, who are often poor and indigent, from thesurrounding area. Teaching hospitals treat many of thesepatients without compensation to provide healthcare tothe local community, but they also do it to maintain acharitable image and to attract charitable contributions.Younis et al. (2001) found teaching hospitals associatedwith financial distress and believed this was the result ofthe costly educational programs they administer and thehigh levels of charitable care they provide.

By contrast, Anderson et al. (1999) did not findteaching status associated with distress. They believedthat the subsidies teaching hospitals receive from Medi-care, the Veteran’s Administration, and other federal andstate governmental agencies make teaching hospitals aparadox. Anderson et al. (1999) believed that teachinghospitals are more expensive and more costly to operatethan non-teaching hospitals, but are less likely to encoun-ter financial distress because social programs subsidizetheir activities.

This study’s researchers hypothesized that teachinghospitals would have more risk of financial distress.

Critical access statusA critical access hospital is a hospital that participates

in the Pennsylvania Medicare Rural Hospital FlexibilityProgram (Flex Program), a program established for ruralhospitals through the BBA. Critical access hospitals mustmeet certain criteria, including being located in ruralareas, having no more than 25 patient beds, furnishing24-hour emergency care services, and having average

annual lengths of stay of 96 hours or less. Additionally,the hospitals must be located more than 35 miles fromthe nearest hospital (the criteria drops to 15 miles inmountainous areas and areas with only secondary roads)or become certified by the state as a necessary providerof healthcare services to residents in the area. Oncedesignated as such, critical access hospitals are reim-bursed by Medicare on a basis of 101 percent of theirallowable and reasonable Medicare costs for mostinpatient and outpatient costs, unless they elect analternative reimbursement scheme.

Critical access hospitals are also reimbursed on areasonable cost basis for their ambulance services, if theyprovide the only ambulance service within a 35-mileradius, and they are not subject to the Inpatient Prospec-tive Payment System (IPPS) or the Hospital OutpatientProspective Payment System (OPPS). The purpose ofthe Flex Program and reimbursement scheme of criticalaccess hospitals is to provide support to hospitals servingremote, rural areas.

As of the date of this research, Pennsylvania haddesignated 12 such critical access hospitals located in 10different rural counties of Pennsylvania. Younis andForgione (2005) did not find critical access status to be asignificant predictor of financial distress.

Given the mixed results, this study’s researchers didnot hypothesize that critical access hospitals are more orless susceptible to financial distress.

Profit statusGeneral acute care hospitals can be formed as for-

profit or nonprofit organizations. The primary purposeof a for-profit organization is to maximize shareholderwealth through profits and accumulated wealth. Non-profit hospitals do not share the same profit-orientedmission, as they strive to maximize services to theirintended constituents. Nonprofit organizations cannotgenerate funds through equity financing as for-profitorganizations can; thus, nonprofit hospitals have fewfinancing options.

This study’s researchers hypothesized that nonprofitstatus increases the risk of financial distress. Thishypothesis is consistent with the research of Langland-Orban et al. (1996), Valvona and Sloan (1988) and Youniset al. (2001), who found that nonprofit hospitals experiencemore financial distress than for-profit hospitals.

System statusHospitals can be formed as stand-alone organizations

or part of a system of organizations. Hospitals thatchoose to become part of a larger system can integratevertically or horizontally. Vertical integration usuallyinvolves the purchase of primary care physician practices(PCPSs), alliances with physicians in physician-hospital


organizations (PHOs), the develop-ment of management service organi-zations (MSOs) or the creation ofhealth maintenance organizations(HMOs). Horizontal integrationusually involves the formation ofmulti-hospital systems, mergers,acquisitions, and strategic allianceswith neighboring hospitals to formnetworks of local hospitals (Burnsand Pauly, 2002). The goals of thesestrategies are similar. Hospitalsseeking to become part of a largersystem through vertical or horizontalintegrations believe such affiliationswill result in better efficiency, lowerrisk, better financial condition,seamless care, more control overreferrals, and higher economies ofscale (Burns and Pauly, 2002).Hospitals that seek system status expectto enjoy higher patient volume, theright to share equipment and facili-ties, and volume purchase discounts.Burns and Pauly (2002), Chan et al.(1999), Langland-Orban et al.(1996) and Nauenberg et al. (1999)did not find system status associatedwith financial distress.

This study’s researchers identifieda hospital as being part of a largersystem if the hospital operatedseveral individually licensed hospi-tals under a single corporate um-brella or when a multi-facilityhealthcare system operated under asingle license. The researchers hypoth-esized that being part of a systemreduces the risk of financial distress.

Financial factorsFinancial factors are more control-

lable than structural factors anddirectly reflect managerial practices.The researchers included the currentratio, the ratio of cash flows to long-term debt, charity care, and patientcost per day in this category ofindicators.

Current ratioThe current ratio measures an

organization’s liquidity, which is theease with which current assets (cash

equivalents, marketable securities,accounts receivable, inventories andprepaid expenses) are converted tocash. The current ratio reflects ahospital’s ability to use its currentassets to pay its current liabilitieswhen due. The current ratio is currentassets divided by current liabilities.Cleverley (1992) found current ratio tobe negatively associated with financialdistress, but only slightly so.

Consistent with these findings, thisstudy’s researchers hypothesized thatas the current ratio increases, the riskof financial distress decreases.

Cash flows to long-term debtCash flows to long-term debt

measures an organization’s solvency,which is a reflection of managerialdecisions regarding the use of long-term debt financing. Managersshould use long-term debt to financecapital improvements and long-termprojects, but long-term debt shouldnot be used in excess or to meetshort-term operating needs. Long-term debt financing must be usedprudently because it creates a debtservice burden–the principal andinterest portions of debt financingmust be repaid to creditors withinspecific timetables. Heavy debtservice costs can result in financialdistress and possibly bankruptcy. Inthis research, the ratio of cash flowsfrom operations to long-term debt wasused to measure solvency. Organiza-tions that have excessive debt or poorcash flows will have lower ratiosthan otherwise. To minimize thevariability in this ratio, the PHC4 capspositive cash flows to debt at 1.0 andnegative cash flows to debt at zero.

This study’s researchers hypoth-esized that as the ratio of cash flows tolong-term debt increases, the likeli-hood of financial distress decreases.This hypothesis is consistent with thefindings of Gapenski, et al. (1993)and Cleverley (1992), who foundhigher levels of long-term debtfinancing positively associated withfinancial distress.

Charity careCharity care reflects the portion of

patient services provided by ahospital that are uncompensated.Charity care also includes bad debts,as charity care includes any careprovided to an indigent, uninsuredand underinsured patient, who lacksthe ability to pay. Most hospitals,even for-profit hospitals, providesome charity care. Bad debt expenseis included in charity care because itrepresents the estimated accountsreceivable that are deemed to beuncollectible. Bad debt is part ofcharity care, even if the hospital didnot originally intend to provide thecare for free. Gapenski et al. (1993)found that charity care impairs long-term financial viability becausehospitals were unable to shiftuncompensated care costs to payingpatients

This study’s researchers measuredcharity care as the sum of bad debtsand uncompensated patient care as apercent of net patient revenue. Thismeasurement did not include reim-bursement shortfalls from Medicareor Medical Assistance. They hypoth-esized that increases in charity carewere associated with increased riskof financial distress.

Patient cost per dayPatient cost per day was measured

as the hospital’s total annual operat-ing expenses divided by the numberof inpatient care days per year. Totaloperating expenses were used insteadof inpatient costs because inpatientcosts were unavailable on the PHC4database. Total operating expensesincluded the costs to maintain thefacility (overhead) as well as inpa-tient care costs. Overhead includeddepreciation and bad debt expense,which are accounting estimates that donot require outlays of cash. However,total operating expenses did notinclude income tax, making it possibleto directly compare for-profit andnonprofit hospitals. Hospitals must


control costs to maintain profitability (Cleverly andHarvey, 1992).

Accordingly, this study’s researchers hypothesized thatas patient cost per day increases, the risk of financialdistress increases.

Patient mixPatient mix includes Medicare, Medical Assistance

(Medicaid), and managed care. Patient mix reflects thetype of reimbursement received for patient services.

MedicareMedicare is a federal program that has existed since

1965 to provide health insurance to people age 65 yearsor older, regardless of their financial means. Medicare isfunded through payroll taxes. It reimburses hospitalsusing a Prospective Payment System (PPS), wherebyhospitals receive set reimbursements based on thediagnosis made of the patients’ illnesses, rather than onthe actual costs incurred. The diagnosis is referred to as a“diagnosis-related group” or DRG. If the hospital doesnot use the entire reimbursement to treat the patient, thehospital can keep the remainder. Some say this can leadto the practice of inflating diagnoses or “DRG-creep”(Simborg, 1981). While some hospital physicians mayoverstate patients’ illnesses to inflate Medicare reim-bursements, Cleverley and Harvey (1992) believed it ismore likely that Medicare reimbursements do not coverthe full cost of treating patients because the PPS did notkeep pace with actual costs.

Cleverley and Harvey posited that the Medicare PPSimpairs a hospital’s long-term financial viability byconsistently failing to cover the hospitals’ actual costs.By contrast, Langland-Orban et al. (1996) said hospitalscan use Medicare to enhance their financial health, ifthey treat just enough Medicare patients to maximizeoccupancy. Sear (2004) said astute hospitals find ways tocompensate for the inadequacies of the PPS, such asshifting unreimbursed costs to private payers, pursuingoutlier payments, and performing more lucrative ser-vices.

This study’s researchers measured Medicare reimburse-ments as the proportion of Medicare revenue relative tonet patient revenues and hypothesized that increasedMedicare reimbursements were associated with increasedexposure to financial distress.

Medical AssistanceMedical Assistance (also referred to as Medicaid) is a

joint state-federal program created in 1965 to providehealthcare to people with limited financial resources.Medical Assistance is the largest source of healthcarefunding in Pennsylvania and provides healthcare re-sources for approximately 3 million eligible poor, needy

and disabled Pennsylvanians. Medical Assistance includesa wide variety of healthcare programs. The programsmost relevant to hospitals are the Inpatient MedicalAssistance Program and Access Plus Program. Theseprograms reimburse GAC hospitals for the inpatient andoutpatient care received by qualifying patients.

At the time of the research, Pennsylvania’s MedicalAssistance program comprised 19 percent of the statebudget and was growing at a rate of 6.2 percent a year.Thus, funding Pennsylvania’s $568 million MedicalAssistance program has become a major budgetary issue.Due to rising healthcare costs, Freidman, et al. (2004)and Lewin (2000) said that Medical Assistance impairs ahospital’s long-term financial viability; however, theywere not sure if this was because Medical Assistancepatients are more costly to treat or the Medicaid reim-bursements are lower than those through private insur-ance.

This study’s researchers measured Medical Assistanceas the proportion of Medicaid revenue relative to netpatient revenue and hypothesized that increases inMedical Assistance were associated with increases in therisk of financial distress.

Managed careManaged care is a term used to describe a variety of

programs initiated in 1973 to reduce healthcare costs.The most common of these programs are network-basedmanaged care programs, such as Health MaintenanceOrganizations (HMOs), Preferred Provider Organizations(PPOs) and Point of Service (POS). These programsseek to reduce unnecessary healthcare costs by providingeconomic incentives for selecting less costly forms oftreatment, by managing treatment plans, controllinginpatient admissions and lengths of stay and establishingcost-sharing incentives for outpatient surgery. The use ofmanaged care is widespread in the U.S., but it is alsocontroversial because critics say it denies needed medicaltreatment, drives down the overall quality of medicalcare, and has done little to control healthcare costs.

Managed care is also criticized for making it difficultfor doctors to spend more time with their patients andfor making it harder for people who are critically ill tosee specialists.

At the same time, managed care is credited for reduc-ing unnecessary hospitalizations through pre-certifica-tions, forcing hospitals to discount their rates, andproviding incentives that encourage greater efficiency.Loubeau and Jantzen (2005) found that hospitals withgreater managed care penetration were associated withlower bond ratings and less profitability. Duffy andFreidman (1993) and Mowll (1998) found that distressedhospitals enter into fewer managed care contracts, butwere unsure whether these hospitals avoided managed


care contracts or were excluded fromthem.

This study’s researchers measuredmanaged care as the proportion ofmanaged care revenue to net patientrevenue and hypothesized thatmanaged care contracts decreased therisk of financial distress.

UtilizationHospital utilization reflects

relatively controllable managerialpractices, such as length of stay,occupancy rate, and inpatient careshare of net patient revenue. Utiliza-tion variables are more controllablethan structural and market factors(Loubeau and Janzen, 2005).

Length of stayLength of stay reflects the average

length of time a patient stays in thehospital as an inpatient. Langland-Orban et al. (1996) found thathospitals with shorter lengths of stayare more financially viable thanhospitals with longer stays. Younisand Cissell (2005) also found shorterlengths of stay associated withprofitability. They believed thatlength of stay is related to financialviability, quality of care and accessi-bility, even when the length of stayinvolves patients with severe ill-nesses.

This study’s researchers measuredthe average length of stay as the ratioof inpatient days to the annual numberof discharges and hypothesized thatlonger lengths of stay increased therisk of financial distress.

Occupancy rateOccupancy rate refers to the

average rate at which a hospitalkeeps its staffed beds filled on anygiven day. Hospitals strive to opti-mize their occupancy rates; however,hospitals can keep their beds fullonly when there is a demand fortheir services. Therefore, occupancyrate reflects the need for inpatientservices in a community (Langland-Orban et al., (1999). Occupancy rate

also reflects the pressures andpractices imposed by the MedicareProspective Payment System andvarious managed care programs(HMOs, PPOs, and POS). Langland-Orban et al. (1996) and Longo andChase (1987) found that hospitalswith high occupancy rates are themost financially viable; however,they recognized that hospitalsbalance the desire to keep their bedsfull with the pressure to keep lengthsof stay shorter and to provide moreoutpatient care.

This study’s researchers measuredoccupancy rate as the ratio of staffedbeds occupied to the total number ofhospital beds and hypothesized thathigher occupancy rates reduced therisk of financial distress.

Inpatient careInpatient care refers to the propor-

tion of total care provided on aninpatient basis. Inpatient care is moreexpensive than outpatient carebecause it is more resource-intensive.Inpatient care is also less profitablethan outpatient care because fee-for-service (outpatient) reimbursementrates are more generous than perdiem rates (inpatient) (Jordan andKeenan, 2001; Soderstrom, et al.,2006). Langland-Orban et al. (1996)believed that emergency roomoutpatient services are one of the fewoutpatient services that typically losemoney.

This study’s researchers measuredinpatient care as the ratio of inpatientrevenue to total net patient revenueand hypothesized that higher inpa-tient care increased the risk offinancial distress.

Market forcesMarket forces are uncontrollable

by hospital managers and reflect theeconomic and socioeconomic condi-tions found in the surroundingcommunity. These factors includecounty poverty rates, percentage ofelderly persons served, and hospitalconcentration.

Poverty ratePoverty rate is the percentage of

families living below the povertythreshold by county. The povertythreshold is the minimum level ofincome deemed necessary to achievean adequate standard of living in theU.S. The poverty threshold is adjustedeach year by the U.S. Census Bureauand is used to develop socioeconomicreforms and public policy. The 2000poverty threshold was approximately$17,050 for a family of four. Kim etal. (2002) found poverty ratespositively associated with thefinancial distress of hospitals. Theysaid low income people wait untilthey are very ill to seek healthcare,thereby increasing the costs requiredto treat them. Kim et al. (2002)posited that hospitals located inimpoverished areas are often the onlysource of healthcare available tothese populations.

This study’s researchers hypoth-esized that higher county povertyrates were associated with a higherrisk of financial distress.

Elderly populationThe elderly population is the

percentage of population over theage of 65. Soderstrom et al. (2006)found that hospitals that serve theelderly have less financial distressthan hospitals that serve youngerpopulations. They said this is due tothe way hospitals code requests forMedicare reimbursements for thetreatment provided to elderlypatients. They believed that hospitalsuse the patient’s most serious illnessto code the treatment to maximizereimbursements.

This study’s researchers estimatedthe proportion of elderly peopletreated by the hospital as the propor-tion of elderly people living in thecounty in which the hospital islocated. The researchers hypoth-esized that hospitals located incounties with higher proportions ofelderly were less likely to be finan-cially distressed.


2 Several prior studies used a different form of regression, called logistic regression, which has been used to study financial distress innonprofit organizations (Greenlee and Trussel, 2000; Trussel, 2002; and Trussel and Greenlee 2004), local governments (Trussel andPatrick, 2007), and hospitals (McCue, 1991). However, the logistic regression approach does not account for the time until financialdistress occurs and does not handle panel data well.

Hospital concentrationHospital concentration serves as a proxy for competi-

tion. Theoretically, financial viability will decrease ascompetition increases (Lynk and Longley, 2002).Supporting this theory is the research of McKay andDorner (1996), who found that rural hospitals becomemore profitable after a neighboring hospital closes. Bycontrast, Gapenski et al. (1993) did not find hospitalconcentration associated with profitability. They believedthese paradoxical findings are due to the fact that patientsdo not usually choose their hospitals.

Despite the contradictory findings, this study’s re-searchers defined hospital concentration as the number ofstaffed beds per hospital divided by the number ofstaffed beds for all hospitals in a county. They hypoth-esized that higher hospital concentration increased therisk of financial distress.

Predicting whether or not a hospital will be-come financially distressed

To predict the financial status of each hospital, theresearchers divided the hospitals into those that were andwere not financially distressed. Although other defini-tions exist, the healthcare literature typically identifiesfinancial distress as declining or negative profits over aperiod of time. Profit margin is the excess of totalrevenues over total expenses divided by total revenues.Financially distressed hospitals were defined in thisresearch as those hospitals with a negative three-yearaverage profit margin during the research period (1997-2006). The PHC4 (2007) also used this definition todefine financially distressed hospitals.

Using these two groups of hospitals (distressed and notdistressed) and the risk factors identified earlier, theresearchers developed a statistical model of financialdistress. This model measured the probability of finan-cial distress as categorical (distressed or not distressed)rather than continuous (zero to one). The time until thehospital experienced distress was also considered. Theresearchers measured the time to financial distress as thenumber of years that passed before the hospital becamefinancially distressed. For example, if a hospital becamefinancially distressed in 2000, then the time to financialdistress was three years, since the study period began in1997.

Time and the risk factors were used as inputs into theregression model, which measured: 1) how well the riskfactors (in total) fit the data; 2) whether or not each riskfactor was significantly related to financial distress; and

3) the probability of a hospital becoming financiallydistressed in each year2. The results also show theprediction of each hospital as financially distressed or notdistressed for each of the 10 years. The researchersclassified each hospital as distressed or not distressed byconsidering the expected cost of misclassifying a hospitaland the prior probability of financial distress (Trusseland Greenlee, 2004). The expected cost of misclassi-fication included the relative costs of misclassifying afinancially distressed hospital as not distressed (a “TypeI” error or misclassification) and the costs of misclassi-fying a hospital that is not financially distressed as dis-tressed (a “Type II” error or misclassification).

Determining the mean ranks of each risk factorfor hospitals that survive and do not survivefinancial distress

The researchers used the risk factors to develop themean ranks of each risk factor for hospitals that survivefinancial distress and fail following financial distress.This part of the study focused only on the financiallydistressed hospitals to determine whether or not theyfailed following distress. In line with previous studies(such as Bazolli and Andes, 1995), a failed hospital is afinancially distressed hospital that closed, merged orchanged ownership during the study period. The status ofthe hospitals was considered through 2007. The ultimatefinancial fate of the hospitals could not be determineddue to the time limitations of the research.

Identifying risk factors associated with finan-cial distress in hospitalsRural vs. urban hospitals

Table 1 reports the mean of the risk factors for thehospitals with breakdowns by rural and urban hospitals.Some of the risk factors indicated that rural hospitalswere more susceptible to financial distress. Rural hospi-tals were smaller than urban hospitals, in both thenumber of beds and total revenues. Rural hospitals hadlower liquidity levels, as determined by the current ratio.Patients stayed longer in rural hospitals, yet occupancyrates were lower. Rural hospitals also operated in coun-ties with higher poverty rates.

Other risk factors indicated that rural hospitals wereless vulnerable to financial distress. Rural hospitals hadhigher operating cash flows in relation to long-term debtand lower patient costs per day. They also operated withless hospital concentration and in counties with larger

Results


Table 2: Financial Status

The data were not adjusted for inflation. Results of t-tests:*Significantly different at less than the 0.05 level.

proportions of the elderly. Ruralhospitals also provided less charityand inpatient care.

Medicare and Medical Assistancewere not significantly differentbetween rural and urban hospitals.

Distressed vs. non-distressedhospitals

Table 2 compares distressed andnon-distressed hospitals, includingboth rural and urban hospitals. Ashypothesized, financially distressedhospitals were smaller in both thenumber of beds and total revenues,and had lower current ratios and cashflows to long-term debt. Theyprovided more charity care, received

more Medicare and Medical Assis-tance, and had lower occupancyrates. Distressed hospitals operated incounties with higher poverty ratesand hospital concentration (competi-tion). The findings also indicatedthat distressed hospitals had lowerpatient costs per day and operated incounties with higher percentages ofthe elderly. Managed care, length ofstay, and inpatient care show nostatistically significant differencesbetween financially distressed andother hospitals.

Table 3 on Page 14 reports thedistress status according to riskfactors such as rural, teaching,critical access, profit and system

status. Twenty-seven percent of ruralhospitals, compared with 34 percentof urban hospitals, were financiallydistressed. Also, as a percent of totalhospitals, there were more non-teaching, critical access and for-profit hospitals that were financiallydistressed. These findings wereopposite of what the researchers ex-pected. For example, the researchersanticipated that a higher percentageof rural hospitals would be distressedcompared to urban hospitals. Onlyone category met that expectation–fewer hospitals with system status werefinancially distressed than thosewithout system status. These resultswere merely a count of the hospitals,

Table 1: Rural vs. Urban Status

The data were not adjusted for inflation. Results of t-tests:*Significantly different at less than the 0.05 level. **Signifi-cantly different at less than the 0.10 level.


however, and did not control for the other risk factorsthat were related to financial distress.

Critical access vs. non-critical access hospitalsTable 4 summarizes the mean risk factors by critical

access status. Compared with other hospitals, criticalaccess hospitals had fewer beds, less total revenue, lowercurrent ratios, and lower cash flows to long-term debt.They provided more charity care, received more MedicalAssistance but less managed care, had longer lengths ofstay and lower occupancy rates, and operated in countieswith higher rates of poverty. All of these factors indi-cated more vulnerability to financial distress.

Other risk factors indicated less vulnerability tofinancial distress. Critical access hospitals provided lessinpatient care, had lower costs per day, and operated incounties with higher proportions of the elderly and lesshospital concentration.

Predicting whether or not a hospital will be-come financially distressed

The second goal of the study was to predict whether ornot a hospital will become financially distressed. Theoutcome related to this goal is a likelihood of financialdistress for each hospital in the sample.

Results of the regression modelThe researchers conducted a multivariate statistical

analysis, where the risk factors were considered simulta-neously as to their overall relationship to the probabilityof financial distress.

The results indicated that the risk factors as a wholewere significantly related to the probability of financialdistress. The results also showed the significance of eachrisk factor when holding all of the other risk factors

constant. All of the risk factors,except critical access status,nonprofit status and systemstatus, were significantlyrelated to financial distress.Medicare was only marginallyrelated to financial distress,statistically speaking. Most ofthe relationships between thesignificant risk factors andfinancial distress were aspredicted; however, three of therisk factors were not related tofinancial distress, as expected.An increase in Medical Assis-tance, an increase in length ofstay and an increase in costs perday decreased the risk offinancial distress.

Table 4: Critical Access Status

The data were not adjusted for inflation. Results of t-tests:*Significantly different at less than the 0.05 level. **Significantlydifferent at less than the 0.10 level.

Table 3: Financial Status

Source: PHC4 data.


The researchers expected lowerMedical Assistance, shorter lengthsof stay and lower costs per day todecrease financial distress.

The finding that lower costs perday was associated with an increasein the risk of financial distress ishighly unusual and could be due tothe fact that the researchers used totaloperating expenses in the calculationof costs per day, rather than inpatientcosts. Total operating expensesincluded depreciation and bad debtexpense, costs that do not require theoutlay of cash. The use of totaloperating expenses may have dis-torted the finding for costs per dayand caused the unexpected result.Although not shown in a table,length of stay and costs per day werenegatively correlated, meaning thatas length of stay increased costs perday decreased.

The finding that financiallydistressed hospitals had shorterlengths of stay was also unexpected;however, length of stay is a complexvariable. The Medicare and MedicalAssistance Prospective PaymentSystems usually reimburse hospitalsfor particular procedures regardlessof how long patients actually stay inthe hospital. These reimbursementsystems would likely cause longerlengths of stay to be associated withhigher unreimbursed costs andgreater risk of distress. Reimburse-ment systems can also be based onper diem rate schedules. In thesecases, longer lengths of stay wouldreduce financial distress, assumingthe rate schedules exceed the actualcosts. The researchers were unable toexplore the unexpected finding forlength of stay because the type ofpayment systems used by the hospi-tals in this study were not availableon the PHC4 database.

Another unexpected result wasthat, controlling for other riskfactors, rural hospitals had less riskof financial distress than their urbancounterparts. The researcherspredicted that, despite Medicare

reform enacted after the BalancedBudget Act of 1997, rural hospitalswould have higher probabilities offinancial distress than urban hospi-tals. This, however, was not the case.As previously discussed, ruralhospitals are smaller than urbanhospitals, operate with longer lengthsof stay, lower occupancy rates, andin counties with higher rates ofpoverty, all of which imply that ruralhospitals have more financialdistress. However, rural hospitalsapparently reduce the risk of finan-cial distress by keeping their costsper day low and minimizing theirinpatient care. They also operate incounties with more elderly patientsand less concentration. Thesefindings help to alleviate the concernsthat rural hospitals have been disen-franchised by Medicare reform.

Reducing the riskof financial distress

If a hospital is at a high probabilityof financial distress, then decision-makers will want to take correctiveaction. One very informative resultfrom the regression analysis was theimpact of a change in a risk factor onthe probability of financial distress.

For example, a relatively small(0.10) increase in the cash-flow-to-debt ratio leads to a 0.11 decrease inthe probability of financial distress.More specifically, if a hospital had acash-flow-to-debt ratio of 0.50 and aprobability of financial distress of0.20, then a 0.10 increase of thecash-flow-to-debt ratio from 0.50 to0.60 would reduce the probability offinancial distress by 0.11 from 0.20to 0.09. A change in this ratio couldbe accomplished by increasing cashflows and/or decreasing debt.

Similarly, moderate to largedecreases in charity care also reducethe risk of financial distress. Charitycare includes all uncompensated care.This primarily includes care pro-vided to patients without the abilityto pay at the outset of the treatment;however, it can also include services

provided to patients with the abilityto pay. Hospitals can reduce theiruncompensated care to ostensiblypaying patients by tightening theircredit policies. They can do this byincreasing their credit standards, sothat only the most credit-worthypatients are granted credit. They canalso shorten the number of dayspatients have to pay their accountsreceivable and heighten their collec-tion efforts when accounts becomedelinquent. Hospitals cannot turnaway patients in times of emergen-cies, but they are not obligated toschedule treatment for patients whomay not pay. Many of these avenueswill be politically unpopular, particu-larly for nonprofit hospitals, butthere are ways for hospitals to reducecharity care.

Moderate to large increases inoccupancy rates also dramaticallyreduce the risk of financial distress.Occupancy rates can be increased bykeeping the hospital beds full ofinpatients and patients. Beds full ofpatients receiving outpatient care aremore economical to treat than bedsoccupied by inpatients. Therefore,hospitals should encourage physi-cians to recommend treatment plansthat involve outpatient rather thaninpatient services, whenever possible.The analysis provides some verypowerful tools for decision-makers,such as hospital administrators, touse to reduce the risk of financialdistress.

For the categorical risk factors(rural, teaching, profit, criticalaccess, and system statuses), reduc-tions in financial distress can beachieved by moving from urban torural, teaching to non-teaching, non-critical access to critical access,nonprofit to for-profit, and system tonon-system status. The biggestimpacts on financial distress areachieved through changes in teachingand rural status. A teaching hospitalhas more risk of financial distress bya factor of 1.69 compared with non-teaching-hospitals. Controlling for


all other risk factors, rural hospitals have a 0.407 lowerprobability of financial distress than urban hospitals.Most of these risk factors, however, are not in the controlof most decision-makers. Even though they may bedifficult or impossible to change, the impacts of changesin these risk factors can influence the likelihood offinancial distress.

Predicting status as financiallyor not financially distressed

Using the results from the Cox Regression analysis, theresearchers computed the probability of financial distressfor each hospital. These probabilities are displayed forall rural hospitals in Appendix A (See Page 24). The nextstep was to use these probabilities to predict whether ornot a hospital is financially distressed. To make thisprediction, the researchers assigned a cutoff probabilityfor classification. A hospital with a probability offinancial distress above the cutoff was predicted to befinancially distressed, while one with a probability equalto or below the cutoff was predicted to be not financiallydistressed.

Following the suggestion of Jones (1987), the research-ers incorporated the expected cost of misclassification(ECM) and the prior probability of fiscal distress, asexplained below. Failure to incorporate these itemsresults in the improper prediction of hospitals as finan-cially distressed or not (Jones 1987, Trussel 2002).

There are two types of classification errors whenpredicting financial distress. Type I errors incorrectlyclassify financially distressed hospitals as not financiallydistressed. Type II errors incorrectly classify hospitals

that are not financially distressed as financially dis-tressed. The ratio of the cost of Type I to Type II errorsmust be determined; however, these costs are difficult toascertain and will depend on the user of the information.For example, creditors wish to minimize loan losses(Type I errors), but will suffer opportunity costs (Type IIerrors) if credit is granted to less credit-worthy borrow-ers at lower rates. The cost of a Type II error is usuallysmaller than a Type I error.

The researchers experimented with various relative costratios (and cutoff probabilities). Consistent with theresearch of Beneish (1999) and Trussel (2002), theresearchers considered the following relativemisclassification costs of Type I to Type II errors: 1:1,10:1, 20:1, 30:1, 50:1 and 100:1. For example, a 10:1ratio means that Type I classification errors are 10 timesas high as Type II classification errors.

To test the usefulness of the model, the researcherscompared these results to a naïve classification strategy.Under a naïve strategy, all hospitals are classified asdistressed (not distressed) when the ratio of relative costsis greater than (less than or equal to) the prior probabil-ity of fiscal distress. If all hospitals are classified asdistressed (not distressed), then the naïve strategy makesno Type I (Type II) errors3.

These results suggest that the financial distress model ismore cost-effective than a naïve strategy, especially afterthe second year. Thus, this model is well suited as anearly warning signal of financial distress due to its abilityto predict financial distress with a relatively high degreeof accuracy and cost-effectiveness.

Probability of financial distress for rural hospitalsThe researchers reported the probability of

financial distress by year for every ruralhospital in Pennsylvania that has complete datawithin the PHC4 database. The probabilitiesare reported in Appendix A for the fiscal yearsended 1997-20064. The probabilities of finan-cial distress for the rural hospitals in AppendixA were compared with various cutoff prob-abilities for each year. If the probabilitycalculated in Appendix A was greater than thecutoff probabilities, then the hospital waspredicted to be financially distressed (and islabeled “yes” under the column “predicted

Table 5: Probability of Financial Distress: CumulativeBaseline Hazard by Year

Source: PHC4 data. Note: The Cumulative Baseline Hazard (H0) is the

conditional probability of financial distress when the risk factors are set tozero. H

0 was derived from the results of the Cox regression analysis. The

Number in Financial Distress is the actual number of hospitals defined asfinancially distressed in each year.

3 In this case, the prior probability of financial distress PI

(not financial distress PII) is zero, and P

II (P

I) is one.

4 The probability of financial distress is computed as:Probability of Financial Distress = h

0 * EXP (B

iX

i),

where h0 is the cumulative baseline hazard, or the

probability of financial distress when all of the riskfactors are zero. EXP (B

i) is the sum of exponential of

each coefficient (B), multiplied by the actual risk factor(X).


distressed” in Appendix A). Classifi-cation as financially distressed wasmerely an indicator based on actualdata and the results from the model.Therefore, readers should use cautionin evaluating the predictions inAppendix A. However, the predic-tions may be used as an earlywarning signal of the risk of finan-cial distress.

Table 5 shows the cumulativebaseline hazard for each year, asdetermined by the model. Table 5also shows the actual number ofhospitals defined as financiallydistressed in each year.

Five rural hospitals with thehighest risk of financial distress

Appendix B (See Page 45) rankseach rural hospital in descendingorder, according to its three-yearaverage of the computed probabilityof financial distress for the years2004 through 2006. The five ruralhospitals with the highest averageprobability of financial distress wereBrownsville General Hospital(Fayette County), Philipsburg AreaHospital (Centre County), AshlandRegional Medical Center (SchuylkillCounty), Sunbury CommunityHospital (Northumberland County),and Palmerton Hospital (Carbon

County). The three rural hospitals onthe list with the highest risk of finan-cial distress underwent significantchanges during the final few years ofthe study period. Brownsville GeneralHospital changed its name in 2005and then closed in January 2006.Philipsburg Area Hospital closed inApril 2006. Ashland RegionalMedical Center changed its name in2006.

Sunbury Community Hospital wasstill in business at the time of thestudy, but had been slipping intodecline during the final seven yearsof the study period. Its ratio droppedfrom 2.34 in 2000 to 0.750 in 2005(results not shown), indicating that itmay have been having troublemeeting its short-term debt obliga-tions. Sunbury’s cash flows to long-term debt ratio had also been drop-ping steadily and was negative forthree of the seven years, indicatingthat it may have been having troublemeeting its long-term debt obliga-tions. Sunbury Community Hospitalhad already reduced its charity careto .024, limiting the option offurther reducing its charity care toreduce the risk of financial distress.

Palmerton Hospital also had a highrisk of financial distress as deter-mined from this model. Its ratio had

been less than 1.0 for the last twoyears of the study period, indicatingthat it may not have been able tomeet its obligations. Its cash flows tolong-term debt had been negative forthree consecutive years, signaling alessening ability to meet long-termdebt obligations.

Risk of financial distress ofcritical access hospitals

In the regression model, criticalaccess status was not significantlyassociated with financial distress;however, 59 percent ofPennsylvania’s critical access hospi-tals were suffering from distresscompared with 29 percent of hospi-tals that did not have critical accessstatus. This finding suggests thatPennsylvania’s critical access hospi-tals are more likely than theircounterparts to be distressed. A closeexamination of critical access hospitalsfinds several severely distressed.

Table 6 lists the critical accesshospitals in descending order of theirthree-year average probability offinancial distress (2004-2006) alongwith some of the more effectivefactors to reduce financial distress.Financial distress can be reducedsignificantly by small increases incash flows to long-term debt,

Table 6: Critical Access Hospitals in Descending Order of Probability of Financial Distress

Source: PHC4 data. The data were not adjusted for inflation. Note: This table shows the critical access hospitals in descending order oftheir three-year (2004-06) average probability of financial distress and the selected risk factors. The statewide averages represent thosefor non-distressed hospitals.


stay and higher proportions of inpatient care, which areexpensive. Barnes Kasson could treat fewer Medicaidpatients until its financial health improves.

An alternative is for one of the two critical accesshospitals in Susquehanna County to close. This researchhas shown that reductions in hospital concentration havea positive impact on financial distress. Later in thisstudy, the researchers show that most failed hospitalsoperated in counties with higher concentrations (such asmore competition). Other research supports the theorythat hospital closings have a positive impact on neighbor-ing rural hospitals (McKay and Dorner, 1996). Thepurpose of the Flex Program is to prevent rural hospitalclosures; however, the financial performance of thesurviving critical access hospital will likely improve ifhospital concentration (competition) is reduced inSusquehanna County.

Tyrone Hospital has been on a downward spiral since2002. Its ratio and cash-flows-to-long-term debt werecritically low (such as its cash flows had been negativefor three consecutive years). Its charity care was alreadylow and its occupancy rates had been climbing. Itappeared to be taking the necessary steps to improve itsperformance, yet it remained financially distressed. Itscosts per day were twice the statewide average, indicat-ing that its total operating expenses were high relative tothe number of inpatients it admits per year. TyroneHospital could improve its financial condition byreducing its operating expenses.

The Meyersdale Community Hospital, Bucktail Medi-cal Center, and Brookville Hospital were also financiallydistressed; however, they did not appear to be in immi-nent risk of failure. The Fulton County Medical Center,Troy Community Hospital, Muncy Valley Hospital, andJersey Shore Hospital were not distressed; however, eventhey could improve their financial conditions by takingany of the actions indicated in this study.

Distinguishing between hospitals that surviveand do not survive financial distress

The third goal of the study was to determine if the riskfactors identified in this study may be used to distinguishbetween financially distressed hospitals that survivefinancial distress and those that fail. The outcome fromthis goal is a comparison of the ranks of the means of therisk factors for the financially distressed hospitals thatsurvive and for those that do not survive.

To make this comparison, the researchers developedtwo groups from the financially distressed hospitals—failed and not failed. A financially distressed hospitalwas defined as failed if it closed, merged or changedownership during the sample period (1997-2007). Allother financially distressed hospitals were defined as not

moderate to large reductions of charity care and moderateto large increases in occupancy rates.

Table 6 shows that Mid-Valley and Corry MemorialHospitals, the two critical access hospitals with thehighest probabilities of financial distress, operate inurban counties. Mid-Valley Hospital has had negativecash flows to debt for nearly all the years in question,indicating that it may have been having difficulty inmeeting its debt service requirements and other long-term obligations. This hospital also has had current ratiosof less than 1.0 for some time, indicating that it may beunable to meet its current obligations. Mid-ValleyHospital has already reduced its charity care to wellbelow the statewide average and did so several years ago.It could attempt to fill its beds with outpatients. Thiswould simultaneously increase its occupancy rate andinpatient share of net patient revenues, which decreasefinancial distress. However, it is doubtful whether Mid-Valley Hospital has the capacity or resources to treatmore patients.

Corry Memorial Hospital also has a high risk offinancial distress. Its ratio was less than 1.0 and its cash-flows-to-long-term debt ratio was relatively low. Thehospital could improve its financial condition by reduc-ing it charity care, as it provided 4.7 percent of its netpatient revenues in charity care, well above the statewideaverage of 3.6 percent.

The remaining hospitals on Table 6 are all rural.Montrose General Hospital might be the most distressedrural, critical access hospital. Montrose General hadpersistent negative cash flows to debt and dangerouslylow current ratios for several years. Montrose Generalhad already reduced its charity care to proportions wellbelow the statewide average. Like Mid-Valley Hospital,Montrose General could strive to increase its occupancyrate by filling its beds with outpatients. MontroseGeneral could also seek to increase its bed size, sinceresearch shows that hospitals maximize profitability at238 beds (Kim, et al, 2002); however, Montrose Generalhas only 22 beds and the Flex Program limits criticalaccess hospitals to 25 beds.

Montrose General Hospital is located in SusquehannaCounty, along with Barnes Kasson County Hospital,which was also in very serious financial condition.Barnes Kasson County Hospital has had low ratios ofcash-flows-to-debt and current ratios for several years,reflecting persistent financial distress. Barnes Kassonalready reduced its charity care and increased its occu-pancy rates; both help to reduce distress.

A key difference between Barnes Kasson and the othercritical access hospitals is that Barnes Kasson treatssignificantly more Medical Assistance (Medicaid)patients. Medicaid is associated with longer lengths of


failed. There were only 16 hospitalsout of 1,495 that met one of thecriteria for failure classification. Dueto this small number, the researcherswere unable to perform typicalstatistical (parametric) tests for thedifferences between the means of thetwo groups.

However, the researchers were ableto perform other tests for the differ-ences between the mean ranks of thetwo groups. Table 7 shows the resultsof these tests. Failed hospitals hadlower cash flows to debt, higher

costs per day, and lower occupancyrates, all of which indicated distress.They also provided more servicesreimbursed through managed careand operated in counties with lowerpercentages of the elderly.

There were no significant differ-ences in the mean ranks of the othervariables. Accordingly, the riskfactors do well in predicting finan-cial distress in hospitals, but do notdo well in predicting whether or notthe financially distressed hospitalswill survive financial distress or fail.

This study evaluated the financialdistress of Pennsylvania’s ruralgeneral acute care hospitals.

It examined risk factors in fivecategories – structural, financial,patient mix, utilization, and marketforces – and found that, controllingfor the risk factors, rural hospitalsare less financially distressed thantheir urban counterparts; however,the findings also indicated that 27percent of these rural hospitals weredistressed during the period coveredby the study (1997-2006). Usingthese risk factors, the researchersdeveloped a model of financialdistress, which correctly classified 67percent to 90 percent of the hospitalsas financially distressed or not overthis 10-year period.

This model of financial distressmay be used as an early warningsignal to identify hospitals that aredistressed and to reduce financialdistress. For example, the studyshowed that financially distressedhospitals reduced their distress byincreasing their total revenues,current ratios, and cash-flows-to-long-term debt. Alternatively,hospitals also reduced their financialdistress by reducing their charity care,inpatient care, and concentration.

Pennsylvania has nearly 100hospitals operating in its ruralcounties. More than one quarter ofthese hospitals were financiallydistressed and three of them hadclosed during the study period.While creditors may be slow to forcehospitals into bankruptcy, financiallydistressed hospitals cannot surviveindefinitely without strategies toimprove their financial condition.The results of this study may be usedby decision-makers to reduce the riskof financial distress.

ConclusionsTable 7: Failure Status(Based on 14 Failed and 448 Not Failed Hospitals)

The data were not adjusted for inflation. Note: Failed status includes thosehospital-years that closed, merged or changed ownership during 1997-2007.*Significantly different at the 0.05 level based on Mann-Whitney U test.**Significantly different at the 0.10 level based on Mann-Whitney U test.


The following policy considerations may help toreduce the risk of financial distress in Pennsylvania’srural and critical access hospitals.

While these recommendations are geared primarilytoward Pennsylvania’s rural and critical access hospitals,they may be extended to Pennsylvania’s urban, nonprofithospitals, as many of those are financially distressed as well.

Policy makers also would benefit from knowing therisk of financial distress in rural hospitals, which hospi-tals are most at risk, and the cause of this risk, if they areto provide effective policy recommendations.

Recommendations related to rural hospitals The Pennsylvania General Assembly should consider

designating a state agency to establish a system to predictand mitigate financial distress in Pennsylvania’s ruralhospitals.

Pennsylvania has a stake in the survival of its ruralhospitals and the health of its rural residents. A list ofrural hospitals and their likelihood of distress is providedin Appendix B. The primary causes of financial distressin Pennsylvania’s rural hospitals are their small size (theaverage size is 137 beds compared to 270 beds for urbanhospitals), their lower occupancy rates (0.582 comparedto 0.661), and the fact that they operate in counties withhigher poverty rates (0.119 compared to 0.111). Asnoted above, rural hospitals can reduce financial distressmost effectively by reducing their level of charity care,increasing their occupancy rates, and increasing theirratios of cash-flows-to-long-term debt (such as relyingless on long-term debt financing). While these changeshave the biggest impact on financial distress, any of thefactors identified in this study can help rural hospitalsavoid and mitigate financial distress.

Given the importance of preserving rural hospitals, thePennsylvania General Assembly should consider estab-lishing a system to predict and mitigate financial distressin Pennsylvania’s rural hospitals. It could do so bydesignating a state agency to monitor the financial healthof Pennsylvania’s nonprofit hospitals. The designeecould use the data collected by the PHC4 and the resultsof this model to identify hospitals that are “at risk” offinancial distress and a set of strategies to combatdistress.

Once these strategies are developed, the designee couldprovide assistance to hospitals that are at risk of financialdistress and those already experiencing distress in anenvironment not unlike that of a small business develop-ment center. While the Pennsylvania Department ofHealth is not currently charged with this function (nor isany other state agency), this concept is consistent withthe Pennsylvania Department of Health’s programmaticgoal to develop a network of support for rural hospitals.

Recommendations related tocritical access hospitals

The Flex Program is a federal government programadministered by state governments. The Pennsylvanialegislature should consider communicating the results ofthis study to the appropriate federal lawmakers.

After controlling for all of the other risk factors, statusas a critical access hospital is not statistically associatedwith financial distress, yet 59 percent of Pennsylvania’scritical access hospitals are in financial distress. Severalcritical access hospitals appeared to be on the verge ofbankruptcy. The Flex Program is designed to preservehealthcare in rural areas, and it is likely that many ofthese hospitals were financially distressed before theywere designated as critical access hospitals; however, oneof the practices required by the Flex Program mayexacerbate financial distress.

The Flex Program requires critical access hospitals toprovide no more than 25 inpatient beds. The extantresearch finds the optimum number of beds to maximizeprofitability to range from 200 to 300 beds (Kim et al.,2002). Kim et al.’s study found that low bed counts donot optimize financial performance. Similarly, this studyfound that, controlling for other risk factors, low bedcounts increase the risk of financial distress. Thus, theFlex Program’s requirement to maintain low bed countscould impair the ability of critical access hospitals toreduce financial distress, if it were present.

The Flex Program also requires critical access hospitalsto maintain an average length of stay of less than 96hours or 4 days. This is less than the statewide average of5.2 days. Some of the existing research found shorterlengths of stay associated with better financial health;however, this study found that, controlling for the otherrisk factors, longer lengths of stay were associated withless risk of financial distress. Given the inconsistency inthe findings regarding length of stay, the researchers donot offer policy recommendations for this factor.

The Medicare reimbursement system of critical accesshospitals is difficult to assess. The system has changedseveral times since 1997 and hospitals can elect alterna-tive reimbursement methods. Assessing the adequacy ofMedicare reimbursements for critical access hospitals iscomplicated by the fact that elderly patients also relyheavily on Medicare reimbursements. These factors makeit difficult to assess the adequacy of Medicare reimburse-ments under the Flex Program.

Finally, to qualify for grants under the Flex Program,participating state governments are required to developorganized systems of health networks to support criticalaccess hospitals. Pursuant to the Flex Program and otherprogrammatic initiatives, such as the Healthy Communi-ties Movement, the Pennsylvania Department of Healthhas been encouraging rural hospitals to participate in a

Policy Considerations


variety of networks, consortia, and alliances. While theseinitiatives may sound intuitively appealing, the extantresearch did not find that networks and healthcaresystems reduced the risk of financial distress. In fact,some arrangements appeared to increase the risk ofdistress (see for example, Chan et al., 1999; Harrison andMcDowell, 2005; and Nauenberg et al., 1999).

In this study, the researchers defined system status asany hospital that operates several individually licensedhospitals under a single corporate umbrella or any multi-facility healthcare system that operates under a singlelicense. Given the wide variety of system types, networksand alliances, policymakers may wish to proceed cautiouslyuntil more is known about the effects of such arrangementson financial distress. It is possible that what sounds intu-itively appealing could actually hinder the financialhealth of Pennsylvania’s already tenuous rural hospitals.

The purpose of the Flex Program is to preservehealthcare in rural areas by supporting critical accesshospitals. This study found many of Pennsylvania’scritical access hospitals to be chronically distressed.Many were undoubtedly distressed before they receivedthe critical access hospital designation. The Flex Pro-gram is a federal government program administered bystate governments. Therefore, state lawmakers have littledirect control over the Flex Program; however, thePennsylvania legislature could inform federal lawmakersthat more than half of Pennsylvania’s critical accesshospitals are financially distressed.

Recommendations related to thesystem status of hospitals

The Pennsylvania Department of Health shouldconsider proceeding cautiously regarding the encourage-ment of system affiliations until more is known about theeffects of such arrangements on financial distress.

In 1999, the Pennsylvania Department of Healthestablished the State Health Improvement Plan RuralSpecial Report Task Force (Task Force) to identify thecauses of healthcare disparities between urban and ruralPennsylvania. The Task Force determined that a lack ofcoordination among rural health care systems andgovernment organizations was the primary cause ofhealthcare disparities in rural communities. Pursuant tothese findings and the U.S. Department of Health andHuman Services’ Healthy People 2010 agenda, thePennsylvania Department of Health began to encouragerural hospitals to form alliances, partnerships, andcooperative arrangements with other hospitals (PA DOH,2000). While there is widespread support for the HealthyCommunities movement, research has shown thatnetwork participation, consortia of rural hospitals, andsystem affiliations yield a variety of financial outcomesand not all of them are beneficial (see Chan, Feldman,

and Manning, 1999; Cleverley, 1992; Sear and Hytoff,2004). This research examined system affiliation andfinancial distress in Pennsylvania’s rural hospitals andfound no statistically significant relationship betweensystem affiliation and financial distress when controllingfor the other risk factors. Accordingly, there is noevidence to suggest that system status significantlyreduces the risk of financial distress.

The Pennsylvania Office of Rural Health administersthe Rural Hospital Flex Program. Pursuant to thisprogram, the Office of Rural Health created 12 criticalaccess hospitals to serve residents in rural communities.This study revealed that while critical access status alonedoes not predict financial distress, several ofPennsylvania’s critical access hospitals are financiallydistressed. See the policy recommendations above forrecommendations on how Pennsylvania’s critical accesshospitals can reduce financial distress.

Recommendations related to theoversight of nonprofit hospitals

The Office of Attorney General should consider usingthe results of this study to enhance its oversight ofPennsylvania’s nonprofit hospitals.

Shortly after the Allegheny Health Education andResearch Foundation (AHERF) went bankrupt, thePennsylvania Office of Attorney General, CharitableTrusts and Organizations Section, began to review thefinancial condition of Pennsylvania’s hospitals. Thesereviews were intended to prevent fraud, since certainAHERF administrators were charged with fraud. TheOffice of Attorney General also reviews all transactionswhen nonprofit hospitals are acquired by for-profitorganizations. Acquisitions are usually made of finan-cially distressed nonprofit hospitals, not healthy hospitals(Harrison and McDowell, 2005). While a hospital’snonprofit status alone cannot predict financial distress,the Office of Attorney General can use this report toenhance its oversight of nonprofit hospital assets, sincethe report identifies Pennsylvania’s financially distressedhospitals, which are most often the targets of takeovers,mergers, and acquisitions.

Recommendations related to allPennsylvania hospitals

Hospital administrators can use the results of this studyto improve the financial condition of all Pennsylvaniahospitals.

This research identified the uncontrollable conditionssurrounding Pennsylvania’s distressed rural hospitals, aswell as the controllable managerial practices employedby those hospitals. Hospital administrators can use thisinformation to gain insight into the practices of the morefinancially viable hospitals.


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Appendix B: Rural Hospitals Ranked by Probability of Financial Distress

(continued on next page)

Note: This table respresents the probability of financial distress for every rural general acute care hospital on the PHC4database during 2004 to 2006. The hospitals are ranked in decending order by the three-year average probability of financialdistress for 2004 to 2006. Higher probabilities represent more risk of financial distress. Cells without data represent caseswith missing data for that year.


Appendix B: Rural Hospitals Ranked by Probability of Financial Distress(continued)

Note: This table respresents the probability of financial distress for every rural general acute care hospital on the PHC4database during 2004 to 2006. The hospitals are ranked in decending order by the three-year average probability of financialdistress for 2004 to 2006. Higher probabilities represent more risk of financial distress. Cells without data represent caseswith missing data for that year.



The financial health of rural hospitals in Pennsylvaniais critical for the health and well-being of patientsserved by these hospitals.

In 2006, 32 percent of hospitals in Pennsylvaniareported financial losses, and a disproportionate shareof these hospitals were small community hospitals inrural areas (Pennsylvania Health Care Cost ContainmentCouncil, 2007).

Over the last two decades, the closure rate for ruralhospitals in the United States has been significantlyhigher than urban hospitals (Chan, 1999). From 1980through 2002, 903 short-term acute hospitals (206urban and 697 rural) closed (American HospitalAssociation, 2004). The closure of rural hospitals hassignificant detrimental consequences on surroundingcommunities that rely on them for needed primary andacute health care services (American Hospital Associa-tion, 2004).

In addition to providing access to critical health careservices, rural hospitals are vital to their local econo-mies because they provide jobs, stimulate local purchas-

Executive Summary

Introduction

The general financial condition of Pennsylvaniahospitals continues to be volatile. In 2006, 32 percent ofhospitals in Pennsylvania reported financial losses and adisproportionate share of these hospitals was smallcommunity hospitals in rural areas.

This study examined rural hospitals and their financialperformance from profitability, liquidity, efficiency,and capital structure perspectives. Financial perfor-mance was examined through key informant interviewswith rural hospital executives and analyzed using theAmerican Hospital Association’s Annual Survey data-base and the Pennsylvania Health Care Cost Contain-ment Council’s Financial and Payer Database from 1997to 2006. Critical access hospitals were identified andassessed separately due to their unique reimbursementand operational factors.

The findings indicate that Pennsylvania’s ruralhospitals must provide continuous primary care to theircommunities while receiving reimbursement that doesnot cover their costs of operation. Many rural hospitalsare located in isolated markets with stagnate populationsand high Medicare and Medical Assistance patientpopulations. These hospitals face increasingly highercosts to recruit and retain physicians and qualified staff.The net result for these rural hospitals is ongoingfinancial losses.

ing, and help attract industry retirees (Doeksen et al.,1990; and Holmes et al., 2006).

This study, which was conducted in 2008, examinedrural Pennsylvania hospitals in terms of their organiza-tional characteristics, local economies, financial health,and patient population to create a profile of theirfinancial health. The researchers used key informantinterviews with rural hospital executives and secondarydata to gain insight into the challenges faced by ruralhospitals.

BackgroundFollowing is background information on patient,

hospital, and local market characteristics of hospitals inrural Pennsylvania counties, along with an overview ofthe financial performance of these hospitals.

This research used the Center for RuralPennsylvania’s definition of a rural county, where acounty is considered rural when the number of personsper square mile is less than 274.

Pennsylvania’s 48 rural counties include a total of 60hospitals. In 2000, nearly 3.4 million residents, or 28percent of the state’s 12.3 million residents, lived in arural county.

The researchers used data from the Center for RuralPennsylvania, the U.S. Census Bureau, the PennsylvaniaHealth Care Cost Containment Council (PHC4), theAmerican Hospital Association (AHA), and publishedliterature to describe the population in Pennsylvaniarural counties.

Patient demographics of Pennsylvania ruralhospitals

Pennsylvania has one of the largest populations ofpersons ages 65 and older (U.S. Census Bureau, 2007).The median age of Pennsylvania rural residents is 40years, but on average, about 17 percent of rural resi-dents are 65 years old or older (U.S. Census Bureau,2007). Nationally, about 12 percent of residents are 65and over, and in urban Pennsylvania counties, 15percent of the population is 65 and over.

In rural Pennsylvania counties, the percent of thepopulation aged 65 years and over ranges from a low of11 percent to a high of 23 percent.

In 2003, about 13 percent of Pennsylvania’s non-elderly population had no health insurance (Pennsylva-nia Rural Health Association, 2005). Patients withoutinsurance place financial stress on hospitals as hospitalsmay be forced to deliver care to these patients and makeup operating losses through cross-subsidization.

Pennsylvania’s adultBasic insurance program offers


comprehensive health benefits to adults between the agesof 19 and 64 who do not have health insurance and meetcertain eligibility criteria. However, the program isunderfunded and so large numbers of Pennsylvanians arenot covered. For example, in May 2009, there were46,127 individuals enrolled in the adultBasic programand 235,574 individuals on the waiting list; 32 percent ofthose on the waiting list were located in rural counties(Pennsylvania Department of Insurance, 2009).

Overall, 13 percent of adults and 6 percent of childrenunder 18 living in rural Pennsylvania are uninsured. Thepercentage of uninsured children and adults in ruralPennsylvania counties is higher than the percentage ofuninsured adults and children in urban Pennsylvaniacounties. However, the range in percentages of ruraluninsured adults and children by county is quite large,with as few as 3 percent to as many as 36 percent ofadults being uninsured, and as few as 1 percent to asmany as 24 percent of children being uninsured (Penn-sylvania Department of Insurance, 2009).

In 2008, the number of uninsured Pennsylvaniansreached more than 1 million, and the majority of themwere working adults (Pennsylvania Department ofInsurance, 2009). Most (62 percent) of the uninsured inPennsylvania are employed adults but lack insurancethrough their employers or cannot afford insuranceoffered by their employers (Pennsylvania Department ofInsurance, 2009).

In May 2008, 8 percent of Pennsylvanians wereuninsured. Nationwide, an average of 15 percent ofresidents were uninsured.

The reasons for the higher percentages of uninsuredresidents in rural Pennsylvania could be associated withthe higher rates of unemployment, poverty and residentseligible for Medical Assistance (the state’s Medicaidprogram) than in urban counties. Another possibleexplanation for the higher rates of uninsured in ruralcounties is that Pennsylvania counties have high propor-tions of small businesses, which are less likely to offerhealth insurance to employees and their dependents(Shields et al., 2007).

All of these factors have the potential to create finan-cial hardship for rural hospitals and barriers to healthcare for rural county residents.

Table 1 includes a comparison of Pennsylvania ruraland urban county demographics.

Market characteristics of Pennsylvania ruralhospitals

The number of hospitals and nursing homes and thenumber of beds available in these facilities are importantindicators of access to health care. From 1990 to 2000,rural Pennsylvania had a small drop in the number ofhospitals (58 to 56). The number of beds, however, fell by

more than 30 percent from 8,776 to 6,038. Over thesame period, hospital admissions fell by 8 percent to247,336 (U.S. Department of Health and Human Services,2008).

Rural community hospitals are the anchor for access tocare in the health care system, a system that includesambulatory care services, rehabilitation, home care,long-term care, behavioral health services, and hospice.In many rural counties, such services only are availablebecause the local hospital has developed them to servethe local patient population.

Rural counties in Pennsylvania have significantly fewerprimary care physicians per 100,000 residents than urbancounties, suggesting that physician shortages couldimpact primary care access for rural Pennsylvaniaresidents. Interviews with hospital administrators indicatethat physician recruitment and retention is one of themain barriers for patients to receive care and a substan-tial cost burden for hospitals.

Table 2 shows the number of inpatient beds, nursinghome beds, and primary care physicians for urban andrural Pennsylvania counties.

To address access issues, Pennsylvania state govern-ment has enacted and/or participated in the followingprograms: the federal Medicare Rural Hospital Flexibil-ity Program, Pennsylvania’s Medical Assistance Programfor safety-net hospitals, Pennsylvania’s Children HealthInsurance Program (CHIP), Pennsylvania’s adultBasicInsurance Program, Medicare and Medical Assistance,and Access Plus.

The federal Medicare Rural Hospital FlexibilityProgram provides for small (less than 25 beds), rural,and financially vulnerable hospitals to convert to critical

Table 1: Demographic Profiles of PennsylvaniaRural and Urban Counties

Source: U.S. Census Bureau, 2007

Table 2: Beds and Physiciansper Resident in PA Rural and Urban Counties

Source: U.S. Department of Health and Human Services, 2008


access hospitals (CAH). With thisdesignation, a hospital receives a 101percent cost-based reimbursementfrom the federal Medicare program.

This reimbursement is importantsince CAHs serve a disproportion-ately high percentage of Medicarepatients. Currently, 13 hospitals insome of Pennsylvania’s smallest ruralcommunities have been designated asCAHs. CAHs that have two or moreyears’ experience in the programhave improved their operatingmargins from an average of -$60,000to $500,000 from fiscal year 2001 tofiscal year 2004 (Pennsylvania RuralHealth Association, 2005).

Although these programs areintended to ensure the financialviability of rural hospitals and accessto care for rural populations, policiesat the state and federal levels con-tinue to cut funding for Pennsylvaniahospitals. Hospitals may be facingspending cuts in Medicare andMedicaid by a total of $280 billionover the next 10 years (Stolberg etal., 2007). Hospitals may alsoexperience cuts from Medicare dueto severity-adjusted DiagnosticRelated Groups (DRGs) that wereintroduced in October 2007 (42 CFR409, 410, 412). Severity-adjustedDRGs could cut payments by 20 to30 percent for many complextreatments and new technologies.

Given these policy changes and thegrowing number of uninsured,Pennsylvania hospitals are facingchallenging financial times.

Literature review onconceptualizing hospitalfinancial performance

This study defined hospital finan-cial performance as the degree towhich a hospital is able to efficientlyoperate and deliver health careservices, maximize positive revenues,minimize the costs of providing healthcare services, and meet and exceed theexpectations of its stakeholders.

The researchers conducted aliterature review to determine the

most common and relevant indicatorsof hospital financial performance.Based on the review, the researchersdetermined the most important andcommonly used indicators forfinancial performance are: liquidity,capital structure, financial activity(asset turnover), and profitability(McCue and Lynch, 1987); profitmargin, return on equity (ROE),total capitalization, debt-to-equityratios, and stock returns (Valvonaand Sloan,1988); ROE and return oninvested assets (ROI) (Cleverly,1992); operational profitability(operating margin); occupancy(average daily occupancy); costs(operating expenses/1000 patient-days) (Goes and Zhan, 1995);operating profit, cost per adjustedadmission, and revenue per adjustedadmission (Chan et al., 1999); andoperating margin, total margin, andreturn on assets (Tennyson andFottler, 2000).

The researchers selected thefollowing financial indicators for thestudy: total margin, operatingmargin, net patient revenues, returnon equity and total net income. Theresearchers selected these financialindicators because they were themost commonly used and widelyaccepted measures of financialprofitability, even though each studycited selected one or more of theindicators to examine.

Financial performancemeasurements

Financial performance is deter-mined by various measurements offinancial margins and ratios (Bazzoli,et al., 2000; Tennyson and Fottler,2000). A financial ratio is simply aratio of two selected values from theorganization’s financial data. Datafor the financial ratio may comefrom income statements, balancesheets, statements of cash flows, orstatements of retained earnings.

Financial ratios allow for compari-sons between companies and indus-tries and are applicable for both for-

profit and nonprofit organizations.Financial statements (income state-ments and balance sheets) containconsiderable detail, and are notuseful for making comparisonsbetween organizations over time(Glandon et al., 1987). Financialratios have emerged as the preferredtool for synthesizing financialinformation and assessing financialperformance (Glandon et al., 1987).Financial ratios provide an efficientmechanism for comparing onehospital with another and with otherorganizations outside the hospitalindustry (Glandon et al., 1987).

While financial ratios are aneffective tool for measuring financialperformance, they have limitations.For instance, financial ratios provideinformation that does not reflect one-time events, such as construction, orone-time charges. Hospitals that haveongoing construction projectsexperience increases in their totalassets, but these assets do not gener-ate revenue until they are complete(Glandon et al., 1987). Financialratios also require several years ofdata to be reliable. Poor performancein a single year or a brief period oftime may not be indicative of poorperformance in the long-run(Glandon et al., 1987).

In summary, extant literaturedefines financial performance with aset of measurements that capturehospital profitability, costs, liquidity,debt/capital structure, asset effi-ciency, and revenue (Bazzoli et al.,2000). However, the hospital finan-cial performance construct is morethan a sum of a series of measure-ments (Curtright et al., 2000).Curtright et al., (2000) argue thatorganizations should not overempha-size one set of indicators, but ratherlink strategic goals to a set ofindicators that measure performanceacross a broad spectrum of categories.

Because one financial performancemeasure is not sufficient, the re-searchers selected several from theliterature to give a broad perspective


of performance. Total margin, operating margin, netpatient revenues, return on equity and total net incomewere the most commonly used and widely acceptedmeasures of financial profitability.

PHC4 assesses the financial health of Pennsylvaniahospitals using the following measurements: totalmargin, operating margin, three-year average totalmargin, net patient revenue (NPR), total operatingexpenses (TOE), percent of uncompensated care, andMedicare share of net patient revenue (NPR), amongothers (PHC4, 2008).

The researchers reviewed executive and Congressionalagency measurements to identify those used to assesshospital financial performance. The federal governmentfocuses on margins and revenues as well as access tocapital, and the cost of providing care to outpatients andinpatients (MedPac, 2009). The federal government paysparticular attention to measurements as they relate totheir largest expenditure for health care through Medi-care reimbursement (MedPac, 2009).

The first goal of the research was to identify appropri-ate indicators that may be used to determine the financialhealth of rural hospitals. To do so, the researchers con-ducted a literature review, as described above, and keyinformant interviews with Pennsylvania rural hospitalexecutives to obtain a list of financial indicators used toassess the financial health of their hospital. The keyinformant interviews with rural Pennsylvania hospitalexecutives also were conducted to examine the impact oforganization structure, local market influences, state andfederal policies, and strategic alliances on the financialperformance of rural hospitals.

The second goal was to assess the financial health ofrural hospitals in Pennsylvania. The researchers usedPHC4 data, AHA data, and key informant interviews toassess the financial health of Pennsylvania’s rural hospi-tals from 2001 to 2006.

The researchers used statistical analyses to determinesignificant differences between the financial performanceof Pennsylvania rural hospitals, Pennsylvania criticalaccess hospitals and all Pennsylvania hospitals to providea meaningful financial comparison of hospitals over time.

Qualitative analysisThe researchers conducted 16 interviews with rural

hospital executive teams (12 hospital and four criticalaccess hospital executives). The interviews providedinsight into the community context of Pennsylvania’srural hospitals and corresponding predictors of financialperformance. The researchers recruited executives from

hospitals with superior, average, and poor financialperformance to participate in the study. To determinefinancial performance, the researchers used the work ofCleverly and Harvey (1992) and Bazzoli et al. (2000),and averaged the hospital performance measurements oftotal margin and operating margin for the period of1997–2006. Hospitals that were in the top quartile forboth mean total margin and operating margin weredefined as superior performers, hospitals in the middlequartile were defined as average performers, and hospi-tals in the bottom quartile were defined as poor financialperformers.

The researchers tried to interview four executive teamsfrom each financial category and from geographicallydispersed areas.

Members of the executive management teams includedthe Chief Executive Officer of the hospital, and in mostcases, the Chief Financial Officer, with other administra-tors present. Major themes of the interviews weredocumented and categorized to create a qualitative studyof the impact of the hospital’s organizational structure,local market structure, and strategic alliances on financialperformance.

Quantitative analysisFor the empirical analysis, the researchers merged the

datasets of the AHA for the years 2001 through 2006 andthe PHC4 for the fiscal years 1997 through 2006.

Hospitals datasets were merged according to hospitalname. Whenever there was a name discrepancy betweenthe two datasets, the researchers made every effort tomatch the correct hospital.

Descriptive statistics and graphs of relevant statisticsfrom the dataset were generated and analyzed to identifytrends and statewide changes that were occurringthroughout the 10-year period (1997-2006). The re-searchers identified and assessed differences between thehospitals in the following groups: urban, rural, criticalaccess hospitals (CAHs), the nine PHC4 regions, bed-sizerange, and three financial performance categories.

Independent and paired means were compared betweenthe respective groups of hospitals to identify statisticaldifferences. Statistical significance was set at .05 for allanalyses. The general linear model was developed aftergrouping rural hospitals into high, medium, and lowgroups in terms of financial performance. Financialperformance for each hospital was based on a percentileranking for mean total margin and mean operatingmargin over the 10-year period. The top 25th percentile,bottom 25th percentile, and the middle 50th percentileswere formed into groups of hospitals. The general linearmodel was developed through step-wise regression andstatistical significance was .05.

The dependent variables used in developing the general

Goal and Objectives

Methodology


linear models were total margin,operating margin, current ratio, cashto long-term debt, and days inaccounts receivable. These measure-ments of financial performance wereused throughout the analysis incomparing the performance ofCAHs, rural hospitals, and the PHC4regions of the state. The independentvariables were for the fiscal years2001 through 2006, as these were theyears for which data were availablefrom both the AHA and PHC4datasets. Hospitals with missing datawere deleted pairwise or a hospitalwith missing values was involved inall analyses except those for whichthe critical values were missing

Hospital executives indicated thesevariables were assessed and moni-tored weekly, and sometimes daily,as they tracked the financial perfor-mance of their organization.

Qualitative analysisAlthough each hospital in rural

Pennsylvania exists in a uniqueenvironment and context, somecommon themes emerged from theinterviews with the rural hospitalexecutives. Below is a summary ofemergent themes from the interviewsbased on the semi-structured inter-view questionnaire.

Community drives the servicesoffered by rural communityhospitals

Top management teams at ruralhospitals are strongly committed totheir mission of serving patients intheir community. Most rural Penn-sylvania hospitals are committed tobalancing services that are profitableand not profitable to serve the needsof the community. In cases where aservice has been unprofitable, manyrural hospitals made the difficultdecision of whether or not to con-tinue offering the service.

It was clear that the decision-making process regarding whatservices to offer at a hospital placed

priority on serving the communityversus maximizing profits for thehospital. Although profitable andunprofitable services varied fromhospital to hospital, commonunprofitable services includedmental health, pediatrics, cardiacrehabilitation, orthopedics, andinpatient services. However, somehospitals reported having to closeunprofitable services because ofsevere financial losses.

Physician recruitment and reten-tion is the top priority and biggestchallenge at rural communityhospitals

It was clear from all of theinterviews with rural hospitalexecutives that physician recruitmentand retention is an ongoing chal-lenge in rural Pennsylvania. Severalreasons were cited for physicianrecruitment and retention difficul-ties, and the most common reasonswere 1) remote rural location, 2)significant on-call duties, 3) the costof malpractice insurance, and 4)salary. Several hospital executivessaid the challenges of recruitingphysicians to their hospitals directlyimpacted the financial performanceof their hospitals, the quality of care,and the services offered to thecommunity.

Nearly all of the intervieweesstated that it was difficult to recruitphysicians to rural Pennsylvania.Most physicians train in urbanenvironments and very few physi-cians want to live in rural places. Tocounter this challenge, many ruralhospitals must pay a significantamount of money to recruit andretain physicians, because physiciansare often willing to accept lessmoney to live in urban environ-ments, and often demand highersalaries to live in rural locations.Many rural hospitals also have tooffer support and subsidize physicianpractices to help recruit and retainthese health care providers. Besideshigher salary costs for physicians,

the costs of subsidizing physicianpractices can be extremely expensivefor hospitals. In fact, some ruralhospital executives reported losing asmuch as $100,000 to $200,000 onthree-year contracts with physiciansdue to high initial start-up costs andlosing patients when a physiciandecides to leave. Hospitals that werefinancially healthy tended not to ownor subsidize any physician practices.

Increasingly, “call” coverage is amajor point of negotiation andcontention when rural hospital execu-tives recruit physicians. A physicianwho is on “call” is available for serviceon short notice. Many rural hospitalexecutives reported that physicianswere unwilling (or refusing) to takecall in a rural environment becausethere is no or little physician backup,and many physicians are unwilling todo inpatient hospital work. Timespent taking call also is disruptive totheir office schedule and reducesreimbursement from procedures thatare performed in the physician’soffice. In general, taking call meansless income and revenue for a physi-cian, who may be struggling already ina rural practice environment. Inresponse, some hospitals have imple-mented hospitalist programs, havepaid for physician call hours, andhired Locum Tenens physicians toprovide around the clock physiciancoverage. Locum Tenens are physi-cians who are hired temporarily onshort-term contracts, and are usuallyvery expensive. All three of thesestrategies cost rural hospitals aconsiderable amount of money.

All rural hospital executivesinterviewed stated that the high costof medical malpractice insurancecontributes to their physician recruit-ing difficulties. In fact, the theme ofmedical malpractice costs came up inevery single interview with ruralhospital executives. For many, thiswas cited as the biggest obstacle inrecruiting physicians to rural Penn-sylvania (as well as the entire state ofPennsylvania). Several executives

Results


expressed the need for medical malpractice reform inPennsylvania and one cited legislation in Texas thathelped ease medical malpractice costs for physicianspracticing in rural Texas.

The interviewees also cited the challenges of recruitingand retaining other clinical staff, such as nurses. Whilethe cost of malpractice insurance is not an issue fornurses and staff, the interviewees mentioned the otherchallenges of rural location, higher salaries and signingbonuses from urban hospitals.

Medical Assistance reimbursement needs to beincreased for rural physicians and hospitals toremain financially viable

Another common theme among the interviewees wasthat physician and hospital reimbursement for MedicalAssistance patients needed to be increased. Executives atrural hospitals said that disproportionate shares of theirpatients were Medical Assistance patients and thatreimbursement rates set for hospitals were unfair,outdated, and favored urban hospitals. They also citedlow Medical Assistance physician reimbursement asanother reason that physician recruitment and retentionwas challenging in rural areas. Indeed, several hospitalexecutives stated that the only way many rural physicianscould make a living by treating Medical Assistancepatients was to be partially or fully employed by thehospital, and in essence, have the hospital subsidize thecosts of treating Medical Assistance patients.

Profitable vs. unprofitable servicesMost interviewees reported a relatively consistent set of

services that were profitable and unprofitable. Allreported losing money on inpatient services but contin-ued to provide inpatient care to meet the needs of thepopulation. Consistent hospital cost drivers included:inpatient services, Medicare services, orthopedics, mentalhealth, transitional care, and cardiac rehabilitation.

Rural community hospitals derive profits throughoutpatient services. The profitable services reportedincluded: outpatient surgery, outpatient diagnostics (suchas MRIs, CT scans), cancer treatment therapy, cardiologyservices, and neurology lab services.

Another factor contributing to the increased cost ofcare is information technology. The financial burden ofachieving the latest technological advancements inpatient care is significant for rural community hospitalswhile the long-term impact of technology on financialperformance remains unclear. Rural community hospitalsface a significant financial burden to keep current withthe latest technological advancements in the industry.Rural community hospitals often invest in technology torecruit physicians who have trained with the technologyand require access to it.

The number of uninsured and underinsured pa-tients continues to rise for many rural hospitals

Many interviewees reported an increase in the numberof uninsured and underinsured patients they are treating.This included more self-pay patients, as well as patientson Medical Assistance, or patients with “bare bones”insurance. Hospital executives reported a rise in theamount of bad debt the hospital incurred due to patientswith high insurance deductibles and/or low reimburse-ment rates, and that many patients are unable or unwill-ing to cover these high deductible costs. These patientsconstitute the underinsured. The interviewees alsoreported an increase in the amount of charity care theyare providing to patients. Increases in the uninsured andunderinsured pose significant financial challenges torural hospitals.

Strategic alliances are beneficial to managing costsand competition for many rural hospitals

For many rural hospitals, strategic alliances are criticalto managing costs, addressing competition, and poten-tially generating revenue. The interviewees said theirhospitals had a variety of strategic alliances and arrange-ments with other organizations, which may be competi-tors. This included alliances with physician groups, otherhospital systems, outpatient clinics, local and nationalhospital associations, rehabilitation clinics, and labora-tory and imaging centers. In several instances, allianceswere formed specifically to manage competition.

Hospital executives reported partnering with physiciangroups or health systems to manage the competition. In apractical sense, this means the alliance was formed tomake the size of the overall “pie” larger and reduce thenumber of patients who were lost to competition tounrelated parties.

Other reasons for forming strategic alliances orpartnerships with other organizations included savingmoney on supplies and malpractice costs, forming jointservices and programs, and gaining access to a networkof knowledge and expertise.

The local market plays a critical role in the successor failure of a rural hospital

Overall, rural hospital executives understand thelimitations of the markets they serve. Many rural hospitalexecutives said that being a sole community hospital canbe advantageous from a competitive standpoint, but mostare more concerned about a weakening local economicmarket rather than direct and immediate competitionfrom competitors. While some rural hospital marketswere certainly facing competition from physician groupsand health systems, most executives reported that aweakening industry and the loss of local businesses werehurting hospital financial performance. Many rural local


markets were losing industries and,with them, the patients who hadprivate insurance. Other marketfactors, such as an aging populationand a declining, young, insuredworkforce, are negatively impactingthe financial performance of ruralhospitals.

Rural community hospitals thatconverted to CAH status reportedexperiencing very poor financialperformance before conversion, andpositive or improved financialperformance after conversion.

Quantitative analysisThe researchers analyzed CAHs

independently and compared themwith one another. The researchersthen examined the financial condi-tions of all rural hospitals in Penn-sylvania, as well as the nine regionsof Pennsylvania, as identified byPHC4.

Many rural hospitals comparedfavorably to their urban counterpartsin terms of profitability, liquidity,capital structure, and efficiency.Among all hospitals, those with an

operating loss were more likely to besmaller community hospitals (PHC4,2008). Only 15 percent (8 out of 52)of the hospitals with negativeoperating margins had annual netpatient revenues above $150 million(PHC4, 2008). A summary offinancial indicators discussed in thisanalysis and their definitions arepresented in Table 3.

The study did not include dataregarding hospital payer marketshare, county market conditions,county demographic characteristics,

or market shares forhospitals. Hospitalpayers are organiza-tions that reimbursehospitals for theirservices to patients.They may includefederal and stategovernments,private insurancecompanies, self-insured employers,or patients who payout of their pocket.

CAHsCAHs are small,

rural hospitals thatare either located35 miles fromanother hospital (or15 miles in areaswith mountainousterrain or onlysecondary roads) orstate-certified asnecessary providersof care. CAHs mayhave a maximum of25 acute care andswing beds andmust maintain anannual averagelength of stay of 96hours or less fortheir acute carepatients. A swingbed is one that can

Table 3: Hospital Financial Performance Indicators,Definitions, and Data Source


be used both to provide general acute care services aswell as skilled nursing care services for patients (Centersfor Medicare and Medicaid Services, 2009). As of thefall of 2008, there were 13 CAHs in operation (Pennsyl-vania Department of Health, 2009).

This study used 10 years of financial data for smallrural hospitals that had CAH status as of December 2007.It provides a picture of industry trends over time. Ananalysis of average pre- and post-conversion performancewas made for a select group of financial performancemeasurements, such as net patient revenue, total operat-ing revenue, total operating expenses, total net income,operating income, operating margin, and total margin.

The number of CAHs has grown from five in 2001 to13 in 2007. Philipsburg Area Hospital opened as a CAHin 2005, but closed in 2006. See Table 4 for a list ofCAHs in Pennsylvania.

CAH profitability assessmentProfitability captures the net impact of many decisions

made by management and offers an assessment of thefinancial performance of the organization (Gapenski,2003). Profitability measures indicate an organization’sprofitability over time. The total margin assesses theability of the organization to manage its expenses(Gapenski, 2003). The higher the total margin, the lowerthe expenses relative to revenues, all else being constant(Gapenski, 2003). The operating margin is defined asoperating income divided by operating revenues(Gapenski, 2003). The advantage of this measurement isits focus on core business operations and the removal oftransitory influences of non-operating sources of revenueand cost, which are often temporary and not related tothe core functions of the hospital (Gapenski, 2003).

The researchers’ assessment of the operating and totalmargins of the Pennsylvania CAHs revealed that they areboth volatile and poor. CAHs have experienced anaverage negative operating margin in five out of six

years they have been in operation throughout Pennsylva-nia. CAHs have experienced mean negative total marginsin four out of six years of operation. Nine out of 13 (69percent) CAHs operated with negative total margins andoperating margins from 2001 through 2006.

A negative operating margin means that the organiza-tion is unable to cover its costs (Gapenski, 2003). Whena hospital is experiencing a negative total margin, moneyis being lost after all sources of revenue and income havebeen assessed (Gapenski, 2003). CAHs have a significantportion of their net patient revenue (NPR) comprised ofreimbursement from outpatient procedures. However,one of the major payers for outpatient services is Medi-care Indemnity (34 percent) and this source of revenueonly covers the actual costs of providing the care.Additional revenue must be generated from privatehealth plans to cover any losses that the CAH experiencesfrom the government reimbursement streams.

There are many factors that contribute to CAHsoperating with negative total and operating margins.While industry averages are unable to provide statisti-cally significant guidance with these measurements, it isuseful to identify the industry average for total margin at5.0 percent (Gapenski, 2003). CAHs may be experienc-ing poor total margins due to the high expenses theymust assume to provide high levels of primary care totheir communities 24 hours per day, seven days a week.Their emergency departments must remain open regard-less of volume and they must have skilled clinicians toprovide coverage in the event of patient demand.

Some CAHs also are providing continuous obstetricsand labor and delivery coverage with skilled staff andphysicians on-call regardless of whether demand for suchservices is high or low.

Rural community hospitals, and CAHs in particular,due to their rural setting, also face very high expenses torecruit and retain physicians who are willing to provideprimary care in a rural setting in a small institution with

limited resources.CAHs also face challenges in generating

revenues. Over half of the revenues for netpatient revenue were generated from govern-ment payers in the form of Medicare andMedical Assistance. Such sources of reim-bursement do not allow the CAHs to covertheir costs of care delivery. For CAHs, themean operating margin was negative from2001 to 2006. This means that, on average,CAHs in Pennsylvania are not making a profitand are losing money.

In comparison, the mean operating marginof all rural hospitals in Pennsylvania waspositive from 2001 to 2006. This means thatrural hospitals in Pennsylvania were not

Table 4: Pennsylvania CAHs as of December 2008

Source: Pennsylvania Office of Rural Health, 2008.


losing money, but their profitmargins were razor thin (in somecases less than 1 percent). However,this is an average operating marginfor CAHs and rural hospitals,meaning there will be variation byindividual hospital.

In summary, CAHs have experi-enced lower operating margins andtotal margins than other ruralhospitals and other communityhospitals throughout the state. Theyface unique challenges operating in arural environment, which contributesto high operating costs and reducedrevenue from patient services.

Pennsylvania CAH liquidityassessment

Liquidity ratios measure the abilityof an organization to pay short-termfinancial obligations (Gapenski,2003). Through an assessment of theamount of cash and other currentassets to the hospital’s currentobligations, ratio analysis assesses theability to pay its bills (Gapenski,2003). The industry average for thecurrent ratio was 2.0, and the averagecurrent ratio for CAHs fell well belowthat benchmark (Gapenski, 2003).

The general trend in the meancurrent ratio was downward, whichindicates that accounts payable werebeing paid more slowly (Gapenski,2003). This may indicate that therewas more financial difficulty overallamong CAHs in meeting theirfinancial obligations. The downwardtrend in mean current ratio may alsoreflect the financial status of hospi-tals that convert to CAH status as alast resort to improve their financialhealth.

The mean current ratio for CAHshas consistently been below theindustry average of 2.0, and that ofrural hospitals and all other GAChospitals throughout Pennsylvania(Gapenski, 2003). From 2001 to2006, the current ratio for rural GAChospitals was below the 2.0 industryaverage and reflected the inability ofsome rural hospitals to meet their

short term financial obligations.In 2009, the current ratio of

hospitals was likely to worsen ascredit markets tighten and access tocapital faces downward pressure. Thecombined influences of tighteningaccess to capital, high Medicare andMedical Assistance populations, andthe decline of patient financialstrength would likely continue tocreate strain on the ability of hospi-tals to meet their short-term financialobligations.

These influences are particularlyimportant for CAHs as they operatewith thin operating and total marginsand are located in isolated areaswhere they cannot draw additionalpatients to maximize volume intoprofitable service lines.

The interviews with key adminis-trators also indicated that CAHs werelimited in their ability to attractspecialists in profitable service areas.The researchers project that thefinancial strain on CAHs willcontinue.

Pennsylvania CAH efficiencyassessment

Efficiency assesses how well anorganization is using its assets toproduce revenue. Efficiency wasassessed through an examination ofCAH occupancy rates and averagecollection periods. The occupancyrate assesses the use of a hospital’sstaffed beds (Gapenski, 2003).

The goal of anefficient organiza-tion is to spread asmuch of the fixedcosts across morepatients, and,therefore, increasethe patient profit-ability ratio(Gapenski, 2003).

The mean CAHoccupancy ratereached its height in2002 at 65 percentand decreasedbefore settling at 59

percent. The relatively high meanoccupancy rate may be due to thesmall number of beds relative to thepatient demand in the hospitalmarket. Relative to the industry,management teams at PennsylvaniaCAHs are doing a good job usingfixed assets to generate revenue fortheir organization. However, theCAHs’ operating margin and totalmargins are going to be hurt if thehigh occupancy rate is due to a highpercentage of Medicare and MedicalAssistance patients using patient beds.

The second measure of efficiencyfor Pennsylvania CAHs was theaverage collection period or days-in-accounts receivable (AR). Thismeasurement focused on the effi-ciency of receivables managementfor the CAHs or the number of daysit takes to collect from payers(Gapenski, 2003).

The industry average was 64 days(Gapenski, 2003). While the overallindustry average was not fullyapplicable to CAHs, it providedguidance as to where other hospitalswere performing relative to theindustry. Table 5 shows that days-in-AR were steadily decreasing byapproximately 25 days for Pennsyl-vania CAHs from 2001 to 2006. It isimportant that CAHs collect theirreceivables as soon as possible tomaximize their revenue and covertheir costs.

On average, in 2006, CAHs days-

Table 5: Mean Days-in-AR for All GAC, RuralGAC, and CAHs, 2001–2006

Data Source: PHC4, 2001–2006.


in-AR was 51, which is extremely highfor organizations that need to maximizetheir cash in the door and maximize theirreimbursement for care services.

Pennsylvania CAHcapital structure analysis

Capital structure analysis assessed howan organization was managing its debt.The measurements demonstrated how anorganization’s operating cash flowscovered debt. The ratio that is useful inthis analysis is the cash-flow-to-long-term-debt ratio (Gapenski, 2003).

There was a wide range of cash-flow-to-long-term-debt ratios across ruralhospitals in Pennsylvania. Some facilitieshad no long-term debt and positive cashflow; such hospitals would have a verylarge ratio (PHC4, 2006). However,other facilities were operating at a lossand may have recorded negative cashflow if their expenses for depreciationand amortization were less than theirlosses for the year (PHC4, 2006).

The lower the cash-flow-to-long-term-debt ratio thenearer a hospital is to negative cash flow (PHC4, 2006).Pennsylvania CAHs experienced their best mean ratio in2002 when both their total and operating margins werethe highest. The 2006 ratio (0.2894) was only slightlyabove the ratio in 2001 (0.2715). Overall, PennsylvaniaCAHs were experiencing high long-term debt.

When compared with other rural hospitals in Pennsyl-vania, the CAHs were in a poorer position to meet theirlong-term debt obligations.

Pennsylvania CAHs have experienced substantialvariation in their ability to meet their long-term debtobligations compared with all other rural hospitals andall GAC hospitals in Pennsylvania. In four of the last sixyears, CAHs’ financial positions have been worse thanother rural hospitals and all other GAC hospitalsthroughout the state. The years 2002 and 2004 were thebest financial years for the CAHs, in terms of theirability to cover their long-term debt obligations, while2005 and 2006 were the weakest in terms of cash-flow-to-long-term debt.

CAH inpatient/outpatient careInpatient services at CAHs remained relatively constant

over the study period. This was most likely due to thestatic nature of the patient populations in which mostCAHs operate. CAHs also faced relatively less competi-tion from other inpatient facilities, with most competi-tion focused on outpatient services, diagnostics, and

therapy services. Patient populations also faced barriersto out-migration from the CAH market due to ruralgeography and limited transportation options.

Average length of stay (ALOS) for CAHs remainedroughly constant from 2002 to 2006. The mean three-year change in ALOS was 19 (n=52) from 2001 to 2006.This was very low throughout the time period. Hospitalunit admissions also remained constant from 2001 to2006, with an average of 1,072 (n=43). Hospital unitinpatient days experienced a substantial spike in 2004before returning to normal ranges in 2006. The averagehospital unit inpatient days for a CAH was 5,886 (n=43)from 2001to 2006.

The mean number of outpatient visits rose continuallybetween 2003 and 2006, reflecting the relatively higherreimbursement rate for outpatient services. Mean totalinpatient days fell throughout 2001 to 2006 for CAHs.According to CAH administrators, Medicare and MedicalAssistance inpatient service reimbursement did not coverthe costs of care, resulting in an investment to increaseoutpatient services to make up for the loss. Figure 1represents the changes in the mean total hospital inpatientdays and the total outpatient visits.

CAH payer mix analysisThe profitability of outpatient services for CAHs is

reflected in their share of net patient revenue (NPR).Mean outpatient revenue as a percentage of NPR wasconsistently higher (2001-2006) than inpatient revenue.This represents an area of opportunity for CAHs. If

Figure 1: Mean Total Hospital Inpatient Days andTotal Outpatient Visits, 2001 – 2006

Data source: PHC4, 1997 – 2006.


CAHs can generate more revenuegrowth in their outpatient services,they may be able to subsidize thesubstantial losses incurred fromdelivering inpatient services. Uncom-pensated care as a percentage of NPRremained steady after an initial jumpfrom 2001 to 2002. Figure 2 showsthe contribution of inpatient, outpa-tient, and uncompensated services toaverage NPR.

For inpatient services, the largestpayer was Medicare. The sharerepresented by Medicare was signifi-cantly larger than any of the otherpayer categories. Medical Assistancewas a distant second. A year-by-yearanalysis from 2001 to 2006 showedthe same picture, with Medicarebeing the largest payer by farthroughout the six-year period.

The large portion of revenuegenerated through Medicare reflectsthe importance of maintaining a highvolume of patients at CAHs, whichreceive cost-based reimbursementfrom Medicare. However, in theinterviews, CAH executives fre-quently mentioned the many chal-lenges in this regard. Barriers to aconsistently high volume of patients

include a lack of referrals fromphysicians, out-migration to largerhospitals that offer specialty andother services, and a very small patientpopulation from which to draw.

The largest payer for CAH outpa-tient services was private healthinsurance (36 percent). This sourceof revenue was closely followed byMedicare (34 percent). A year-by-year analysis from 2001 to 2006provided the same picture, withprivate health insurance being thelargest payer throughout the six-yearperiod. The large percentage ofprivate insurance reimbursement foroutpatient procedures supports theargument for growth in this area sothat CAHs may cross-subsidize themoney lost on Medicare and MedicalAssistance services. The profitabilityof outpatient services was confirmedthrough the interviews with theexecutive management teams.

Ambulatory surgery, diagnostics,therapy, and cancer treatmentprovide significant opportunities forCAHs to generate revenue fromcommercial payers.

CAHs uncompensated careSince 2002, the percentage of

uncompensated care for CAHs hassteadily declined from a mean ofgreater than 5 percent to less than 4percent. However, the patientpopulations surrounding CAHs arefacing increasing pressure from theeconomic downturn at the state andnational levels. Many CAHs operatein markets where industries have left,uninsured patient levels continue torise, and many people rely on out-of-pocket payment for health services.As CAHs continue to provideprimary care to their patient commu-nities, the impact of uninsuredpatients will continue to be a factorin their financial health.

Uncompensated care has manysources, according to CAH adminis-trators. They mentioned that, inaddition to patients who lack healthinsurance, many were alsounderinsured and many were unpre-pared to pay their copayments anddeductibles. The share of uncompen-sated care and bad debt may continueto increase for many CAHs. Thistrend is likely to increase as employ-ers continue to shift the costs ofhealth care to their employees in theform of out-of-pocket costs, such asdeductibles and copays (Fuhrmans,2008). Employees’ total share ofhealth care costs were projected toincrease by 9 percent in 2009(Fuhrmans, 2008). The costs forpeople that use more care areprojected to increase at an evensteeper rate, specifically a 10 percentincrease in out-of-pocket costs, suchas deductibles and copays, is pro-jected (Fuhrmans, 2008).

Regional analysisThe researchers used the regions as

defined by PHC4 for this study (SeeFigure 3 on Page 58). Pennsylvaniais comprised of nine regions: regions1 through 7 have at least one ruralcounty, and regions 2 through 7 havemostly rural counties.

Figure 2: Mean Inpatient Share of NPR, Mean Outpatient Shareof NPR, and Mean Percent of Uncompensated Care

Data Source: PHC4, 1997 – 2006.


Overall, there was no single region that consistentlyperformed better relative to others and there was noregion that consistently performed worse. The regionswith the best mean operating (Region 3) and totalmargins (Region 5) primarily included rural and urbancounties with small to mid-size hospitals. Region 3 hadthe best performance in current ratio, or the averagehospital’s ability to meet its short term obligations.

Region 2, which is comprised primarily of ruralcounties, was the best performer for average collectionperiod, with a mean collection period of 53 days inaccounts receivable. The worst performer for averagecollection period was Region 8, which is comprised ofmostly urban counties, with an average of 111 days inaccounts receivable. The high mean number of days forcollections in Region 8 may reflect opportunities forhospitals to engage in aggressive account managementand reengineering of revenue cycle processes. The meanof 111 days was well above the industry average of 64days (Gapenski, 2003).

Region 9 was the best performer in occupancy rate,which may reflect a population requiring more inpatientdays for recovery. Region 9 includes only urban countiesand the hospitals in the region provide services topatients who are at a higher acuity or may not have othercare options. There are also a large number of teachinghospitals in Region 9 affiliated with universities withgraduate medical educational programs.

Region 4, which includes all rural counties and smaller,shorter-stay hospitals, had the lowest mean occupancyrate. Perhaps more acute patients are transferred totertiary centers for specialized care, which reduces theoverall mean occupancy rate for Region 4.

Region 9 was the best performer for both NPR andtotal operating revenue (TOR). The higher numbers mostlikely reflect the higher average bed size and volume ofhospitals located in Region 9. Smaller hospitals locatedin rural regions experienced much smaller mean NPRand TOR figures.

Region 4 experienced the lowest mean NPR and TOR,which reflects the smaller-size and lower volume ofhospitals located in a mostly rural region in centralPennsylvania.

Region 6, populated with both urban and rural coun-ties, had the lowest mean cash-flow-to-long-term debt,operating income (OI) and total net income (TNI). Thelow mean OI, TNI, and cash flow to long-term debtexperienced by this region may reflect the market shareand control of the dominate payer – Blue Cross ofNortheastern Pennsylvania.

Overall, Regions 3 and 5 had the most “best-perform-ing” categories. Both regions were the best performers inoperating margin, total margin, current ratio, total netincome, and total operating costs. These regions arelocated in the south-central region of Pennsylvania andare comprised of both rural and urban counties. Theyface competition from providers along the Marylandborder, but according to hospital administrators, are inmuch better financial health than other hospitals inPennsylvania. The dominate payer in the region isCapital Blue Cross and many of the patients in theseregions are members of private commercial plans.

Analysis for all rural hospitalsThis section analyzes the financial condition of hospi-

tals located in rural counties.

Rural GAC liquidity assessmentThe liquidity assessment for rural hospitals focused on

their ability to meet cash obligations in a timely fashion(Gapenski, 2003). The current ratio provided a picture ofthe relationship between current assets and cash-to-short-term obligations for the hospital (Gapenski, 2003).

The current ratio for rural GAC hospitals has consis-tently been worse than hospitals located in urban countiesand the overall state average. From 2005 to 2006, ruralhospitals have exhibited a better ability to meet currentobligations, on average, than urban hospitals. Ruralhospitals face increasing cost pressure and decreasedreimbursement, but perhaps urban hospitals are bearingeven more cost pressure in the last several years. Table 6provides a picture of the yearly average current ratio forrural, urban, and all Pennsylvania hospitals from 1997through 2006.

From 2005 through 2006, rural hospitals were betterpositioned to meet their short term obligations than therest of the hospitals throughout Pennsylvania. Urbanhospitals also may have been experiencing increases incosts due to more patients seeking care who lack insuranceor who are unable to meet their deductibles or co-pays.

Figure 3: PHC4s Geographic Regionsin Pennsylvania, 2008

Data source: PHC4, 2008.


Rural GAC efficiency assessmentThe efficiency analysis for rural

GAC hospitals assessed how effectiverural hospitals were in managingreceivables and their occupancy rate.Overall, rural GAC hospitals havemanaged their patient accounts andenjoyed lower days-in-AR than bothurban and the average hospitalstatewide. They also have a highermean occupancy rate than urbanhospitals and the average hospitalstatewide.

Cash flowThe average Pennsylvania hospital

has enjoyed a steady decrease in thenumber of days-in-AR. The averagefor all hospitals in 2000 was slightlymore than 112 days, and, in 2006,this fell to slightly more than 47 daysin AR for a decrease of 58 percent,on average. Rural hospitals haveexperienced much lower and consis-tent days-in-AR throughout the sameperiod. However, they have also seena reduction by 28 percent in days-in-AR, from 64 to 46 (PHC4, 2006).Gapenski (2003) defines the industryaverage for days-in-AR as 64 days, a

level the averagerural Pennsylvaniahospital is wellbelow.

In terms of theaverage number ofdays-in-AR, ruralhospitals startedsubstantially lowerin 1997 than theirurban counterparts.The mean for ruralhospitals remainedconsistent from2004 through 2006.Interviews withadministrators inrural hospitalsrevealed that theyexperienced veryfavorable levels ofdays-in-AR. Other

concerns, such as reimbursementlevel, cost management, patientvolume, and physician access,outweighed the concerns regardingdelays in revenue due to days-in-AR.

Occupancy ratesThe mean occupancy rate for rural

hospitals fell below the overallaverage for Pennsylvania hospitalsand the average urban hospital. Theformula used for the available datameasures the extent of use of ahospital’s staffed beds or their fixedassets (Gapenski, 2003; PHC4,2006). Overhead costs are spreadover all assets, including staffedbeds, and whether or not they areoccupied (Gapenski, 2003). A higheroccupancy rate translates into morefixed costs spread over more patientsand increases per patient profitability(Gapenski, 2003). The occupancyrate for rural hospitals from 1997 to2006 was consistently below urbanhospitals and the statewide average.

Lower occupancy rates for ruralhospitals mean lower reimbursementlevels for inpatient care. Accordingto rural hospital administrators, ruralproviders have limited options to

increase their occupancy rates. Theirpatient population is stagnant, newbusinesses do not enter their market,there is out-migration to largerorganizations, physician access islimited, new physicians are difficultto recruit, and insufficient patientpopulation levels do not supportspecialist care. These conditions mayprovide support for reimbursingCAHs and other smaller ruralhospitals with high levels of MedicalAssistance patients at a reimburse-ment rate that is higher than whatthey are currently receiving.

Capital structureCash flow is a top priority for all

rural hospitals. Rural hospitalsoperate on extremely thin marginsand the ratio of cash-flow-to-long-term liabilities is extremely impor-tant for the long-term viability of theorganization. The capital structure ofrural hospitals was assessed bymeasuring cash-flow-to-long-termdebt (LTD). The cash-flow-to-LTDratio addresses the need to know howa hospital meets fixed financialcharges in addition to interestpayments. The ratio also captureshow the actual cash flow is meetingfixed charge payments (Gapenski,2003). There was a wide range ofratios with rural hospitals. Therewere a few organizations that hadvery little or no long-term debt andhealthy cash flows. These facilitiesenjoyed a very large ratio and thedata capped their ratio at 100 percent(PHC4, 2006).

Unfortunately, many rural hospi-tals operated at a loss, with negativetotal margins and negative cash flow.Negative cash flow typically occurswhenever a hospital has largedepreciation and amortizationexpenses. A negative cash flowresults in a negative ratio, and thedata capped their ratio at 0 percent(PHC4, 2006).

The mean cash-to-LTD ratio forrural hospitals was consistently betterthan the mean for urban hospitals

Table 6: Mean Current Ratio for Rural,Urban, and All GAC Hospitals, 1997 – 2006

Data source: PHC4, 1997 – 2006.


from 1997 through 2003. However, from 2003 through2006, urban hospitals consistently outperformed ruralhospitals. Still, since 2003, both rural and urban hospi-tals have experienced improved cash-to-LTD ratios.

The steady improvement in this ratio for rural hospitalsreflects increases in their cash flow and perhaps adecrease in their long-term debt burden. Rural hospitalshave been able to diversify and invest in high marginservices as well as cut their costs to improve cash flow.However, many rural hospitals continue to face chal-lenges in generating positive revenue in an environmentof low reimbursement for Medicare and Medical Assis-tance patients and high costs for staffing, technology, andthe recruitment and retention of physicians and staff, andsupplies.

ProfitabilityThe profitability of a rural hospital is impacted by a

wide array of managerial decisions and strategies(Gapenski, 2003). Two measures of the overall perfor-mance of the organization are the operating profitmargin and the total profit margin.

Rural hospitals had experienced, on average, betteroperating profit margins than urban hospitals until 2005– that’s when they fell below the mean margins of urbancounty hospitals. In 2003 and 2005, the average profitmargins for urban and rural hospitals were almostidentical. The mean profit margins for rural hospitalswere negative for two of the 10 years between 1997 and2006. However, this compared favorably with theaverage negative margins experienced by urban hospitals.Urban hospitals experienced mean negative total profitmargins 50 percent of the time from 1997 through 2006.However, from 2003 through 2006, urban hospitalsexperienced positive total profit margins after experienc-ing several years of negative total profit margins.

Hospital administrators reported that expenses forstaffing, recruiting and retaining physicians, providingservices that lost money but were critical to the health ofthe community, and supply purchases contributed to theirheavy expense burden.

Administrators also reported limits in their ability tonegotiate with large payers for favorable reimbursementlevels. Hospitals that were stand-alone, small, andrelying on the major payer in the market for theirrevenue often negotiate from a position of weakness.Such a negotiating process often leads to reimbursementarrangements that have high allowances or relativelylower reimbursement for the hospital.

Hospital administrators reported that both state andfederal reimbursement for small community hospitals donot cover their costs of operation. The negative operatingmargins experienced by Pennsylvania hospitals providedsupport for this assertion. Hospitals that continue to offer

primary care services that are needed by their communityoften operate such services at a loss, which contributes tothe negative margins.

The mean operating profit margins for rural hospitalswere consistently above their urban counterparts and thestatewide average from 1997 through 2003. Ruralhospitals’ mean operating profit margins were at theirlowest in 1999 and dipped again in 2003. In the last yearfor which data were available for this study, rural meanoperating profit margins fell below their urban counter-parts and their statewide average.

Gapenski (2003) identifies the industry average forhospital total profit margin as 5 percent and both Penn-sylvania urban and rural hospitals were well below thatfigure.

The total profit margin assesses the organization’sability to control its expenses. A high total profit marginindicates that expenses are lower relative to revenues(Gapenski, 2003). A high total profit margin may comefrom high gross charges, low allowances, low costs, highnon-operating income, or any combination of thesefactors (Gapenski, 2003).

Margins for rural Pennsylvania hospitals fell consis-tently from 1997 through 2003 and then fell again from2005 to 2006, the last year for which data were availablefor this study. Compared with the mean urban totalmargin, rural hospitals outperformed urban hospitalsevery year except 2003 and 2006.

There are many reasons why rural hospitals haveexperienced relatively better average total profit marginsthan their urban counterparts. Rural hospitals were ableto more effectively control their expenses than urbanhospitals. Competition among urban hospitals may haveled to lower gross charges and subsequent reimburse-ment. Rural hospitals may have had high non-operatingincome from other sources. Other sources of non-operating income include sources from foundations,investment portfolios, sale and rental of property,charitable donations, tax-free bond issuance, and grantsfrom state and federal governments (Dalton et al., 2008;Smith et al., 1995). Additional analysis at the operationalbasis would be required to identify the mechanisms forthe high mean total profit margin for rural hospitals.

The payer mix comparison between rural and urbanhospitals indicated that, on average, from 1997 through2006, rural hospitals had a higher percentage of theirNPR from Medicare (with 95 percent confidence) andprivate insurance than urban hospitals. The share of NPRfrom private insurance was 30 percent for rural hospitalsand 27 percent for urban hospitals. The share of NPRfrom Medicare was significantly higher (with 95 percentconfidence) for rural hospitals than for urban hospitals,42 percent compared with 34 percent. Urban hospitals hada significantly higher (with 95 percent confidence) percent-


age of their NPR from managed care,28 percent compared with 19 percentfor rural hospitals. Urban hospitals alsohad a higher (with 95 percent confi-dence) share of their NPR fromMedical Assistance than their ruralcounterparts.

The payer mix analysis mayexplain the differences in theoperating and total profit marginsfor urban and rural hospitals. Urbanhospitals received a significantlyhigher percentage of their NPR frommanaged care and Medical Assis-tance (with 95 percent confidence),and less from Medicare (with 95percent confidence) and privateinsurance.

Overall predictors of ruralhospital financial performance

For the final analysis, the re-searchers developed a general linearstatistical model after grouping ruralhospitals into high, medium, andlow groups in terms of their finan-cial performance. Financial perfor-mance for each hospital was basedon a percentile ranking for meantotal margin and mean operatingmargin over the 10-year period of1997-2006. The top 25th percentile,bottom 25th percentile, and themiddle 50th percentiles were formedinto groups of hospitals.

The organizational structure ofhospitals operating in the top 25thpercentile was found to be the mostreliable indicator of financialperformance. Organizational struc-ture was comprised of size, payermix, and service line variables.Payer mix variables, such as percentof uncompensated care and Medicaremanaged care share of inpatientrevenue, had the most impact onfinancial status. Service variables,such as rehabilitation days, occu-pancy rate, and staffed beds, werealso statistically significant predic-tors of financial status. Participationin a hospital network also was foundto be statistically significant among

hospitals with strong financialperformance.

The organizational structure ofhospitals operating in the bottom25th percentile was also the mostreliable indicator of financialperformance. Hospital occupancy

Table 7: Mean Total Margin, Net Income, and OperatingRevenue and Quartiles for Rural GAC Hospitals, 1997–2001

Data Source: PHC4, 1997 - 2006. (continued on next page)

rate, length of stay, hospital size, andpayer mix variables were the moststatistically reliable. Average lengthof stay, volume of outpatient visits,skilled nursing staffed beds, homehealth, and managed care reimburse-ment were the most statistically


ConclusionsThe financial health of Pennsylvania’s rural andcritical access hospitals

Rural hospitals have experienced, on average, betterprofitability as measured by their operating margins thanurban hospitals until 2005, when they fell below themean margins of urban county hospitals. Mean totalmargins for rural hospitals fell consistently from 1997

through 2003 and then fell againfrom 2005 to 2006, the last year forwhich data were available for thisstudy. Compared with the meanurban total margins, rural hospitalshave outperformed urban hospitalsevery year except 2003 and 2006.

From 1997 through 2006, liquid-ity (meaning the amount of cash thehospital has) performance wasworse than urban hospitals. Theperformance of rural hospitals,when compared with their urbancounterparts, was mixed in terms ofefficiency, as measured by theiroccupancy and accounts receivablemanagement. Rural hospitals wereworse off than their urban counter-parts from a cash flow perspective.Poor cash flow contributes to theirconsistently low and negativeoperating and total margins. Cashflow and liquidity are also impor-tant to rural hospitals because theyneed short term cash to purchasesupplies and equipment, and tosupport hospital infrastructure.Without this cash, the deteriorationof rural hospital infrastructurescould negatively impact patientcare.

With only a few exceptions,critical access hospitals were amongthe worst performing hospitals overthe 10-year study period. Manycritical access hospitals operate withhigh expenses and negative total andoperating margins. The federalcritical access hospital designationand Medicare cost-based reimburse-

Table 7: Mean Total Margin, Net Income, and OperatingRevenue and Quartiles for Rural GAC Hospitals, 1997–2001

Data Source: PHC4, 1997 - 2006.

significant variables for the worst performing hospitals.Hospitals operating in the middle 50th percentile of

performance were most impacted by the control type orownership type of the hospitals.

For comparison purposes, the researchers ranked eachof the rural hospitals according to their financial perfor-mance. The main indicators of financial performance theresearchers used for this comparison were 10-yearaverage total margin, net income, and operating revenue.They then ranked the hospitals into quartiles, accordingto their average nine-year performance for each of theindicators. Top performers were ranked in the 1st

quartile, and poor performers were ranked in the 4th

quartile. Table 7 shows which rural hospitals werestruggling the most.


ment did not seem to enable them toimprove their performance substan-tially. However, findings from thisstudy suggest that strategic alliances,either through system membershipand/or alliances with physiciangroups, other hospital systems(sometimes competitors), outpatientclinics, and local and nationalhospital associations, may help ruralhospitals increase their efficiency,manage competition, and increaseaccess to capital and human re-sources.

Additional financial performancedata are required to assess theperformance trends after 2006.Hospital market share, payer marketshare, and physician access data arenecessary to determine the impact oflocal market and payer influences onfinancial performance. Despite theuncertain financial outlook for ruralhospitals in Pennsylvania, many ruralhospital executives continue strivingto provide comprehensive, highquality care to their communities.Given the negative cash flow thatmost of them have experienced overthe years, it is remarkable that theymanage to stay open. It is undoubt-edly the support from local commu-nities, through gifts and fundraising,that keeps these valuable institutionsafloat. Many rural hospitals have alsomade significant efforts to cut costsand eliminate waste and unnecessarycosts. However, rural hospitals canonly face negative cash flow andcompounding debt for so long beforethey are forced to close their doorspermanently. Only state policies havethe potential to remedy these finan-cial trends for rural hospitals.

Financial trends and the health ofrural and critical access hospitalsin Pennsylvania.

The financial health of ruralhospitals and critical access hospitalsin Pennsylvania is fragile. Accordingto PHC4 data, in 2007, more thanone-third of Pennsylvania’s general

acute care hospitals were in signifi-cant financial distress, and two-thirdswere performing at levels consideredto be below long-term economicviability (PHC4, 2007). Ruralhospitals and critical access hospitalsare providing critical primary care infacilities and with equipment that areaging beyond the national average(PHC4, 2007). Rural hospitals alsoare facing increased competitionfrom other community hospitals,physician offices, and larger distanthospitals. The number of stand-alonefacilities in Pennsylvania, such asambulatory surgery centers, hasquadrupled since fiscal year 1996,growing from 44 in fiscal year 1996to 177 in fiscal year 2005 (PHC4,2007).

Physician recruitment and reten-tion places a substantial cost burdenon rural and critical access hospitals.Rural hospitals are caught in avicious cycle of recruiting physiciansand staff, paying high salaries toretain them, and then losing them tourban centers. Such costs are neces-sary, but loss-generating, due to thenecessity of relying on physicians forcritical inpatient admissions. Thestudy findings support other researchthat has shown severe gaps in thesupply of physicians in Pennsylvania(The Hospital and HealthsystemAssociation of Pennsylvania and thePennsylvania Medical Society,2008). According to the Pennsylva-nia Medical Society, Pennsylvaniahas a severe shortage of physicians,especially in the specialty areas oforthopedics, radiology, cardiology,family practice, internal medicine,obstetrics/gynecology, and pediatrics(2008). Interviews with ruralhospital executives confirmedshortages in these same specialties.Reports from the PennsylvaniaDepartment of Health (DOH)indicate that between 2004 and 2006,Pennsylvania lost 1,632 physicians(DOH, 2007). The DOH estimates

that the southeast and south-centralregions have suffered the highestphysician losses. These losses arepredicted to continue, unless policychanges at the state make Pennsylva-nia a more physician-friendlyenvironment (DOH, 2007).

Rural hospitals and critical accesshospitals must provide more care formore patients who are elderly,underinsured, or uninsured. Medicarereimbursement continues to shrinkand the costs of treating Medicarepatients, who are sicker and moreexpensive, must be shifted to privateinsurers – even though the portion ofinpatient discharges covered byMedicare has increased and theportion covered by private insurershas decreased (PHC4, 2007). Indeed,the influx of new Medicare Advan-tage plans has created additionalcomplications in collecting reim-bursement for Medicare patients.Although MA plans, more often thannot, reimburse critical access hospi-tals at a level equivalent to tradi-tional Medicare, many contractsmake no provisions for an annual oryear-end cost settlement (NORCWalsh Center for Rural HealthAnalysis and RUPRI Center forRural Health Policy Analysis, 2008).The NORC report found that criticalaccess hospitals rejected contractswith Medicare Advantage plans forthe following reasons: inadequatereimbursement terms, administrativeconcerns, or low Medicare Advan-tage penetration in the area. Eventhough the NORC report focusedonly critical access hospitals, find-ings from this study suggest that thenew Medicare Advantage plans donot adequately reimburse ruralhospitals for the cost of care, andalso do not recognize “sole provider”hospital status (as many ruralhospitals are within their commu-nity). This lack of recognition byMedicare Advantage plans for soleprovider status further impactsPennsylvania rural hospitals’ ability


to receive fair and adequate reimbursement for treatingMedicare patients.

Rural hospitals are responding to their difficult eco-nomic environment and reimbursement levels by cuttingcosts.

Other reports suggest that the current economic crisis isdirectly impacting Pennsylvania’s rural hospitals (TheHospital and Healthsystem Association of Pennsylvania,2009). Reports suggest that Pennsylvania hospitals areexperiencing declines in investment income, increasedexpense of capital, increased borrowing requirements,difficulty refinancing debt, inability to issue bonds, and

inability to renew lines of credit (The Hospital andHealthsystem Association of Pennsylvania, 2009).

As this research shows, rural hospitals were alreadyfacing negative profit levels and cash liquidity problems.Even profitable rural hospitals are often operating onrazor-thin margins. The current economic crisis leavesrural hospitals even more strapped for cash to providecare to the patients who depend on them. Given thatrural hospitals are often one of the largest employers intheir areas and counties, it is vital that state policies helpsupport these community safety nets.

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The Center for Rural PennsylvaniaBoard of Directors

The Center for Rural Pennsylvania625 Forster St., Room 902

Harrisburg, PA 17120phone (717) 787-9555

fax (717) 772-3587www.rural.palegislature.us

1P0310-550

Senator John R. GordnerChairman

Representative Tina PickettVice Chairman

Senator John WozniakTreasurer

Dr. Nancy FalvoClarion University

Secretary

Representative Tim Seip

Dr. Theodore R. AlterPennsylvania State University

Dr. Stephan J. GoetzNortheast Regional Center

for Rural Development

Dr. Keith T. MillerLock Haven University

Dr. Robert F. PackUniversity of Pittsburgh

William SturgesGovernor’s Representative

Dan A. SurraGovernor’s Representative

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