Nine Key Factors Driving Hospital Valuations
There are nuances in providing valuations for virtually every type of business entity ranging from retail outlets to a manufacturing operation to a personal services firms. But valuations for hospitals and other organizations in the health care field are especially daunting.
Currently, hospitals face some unique challenges, including difficult economic conditions, increased competition and burdensome reporting requirements. In addition, the provisions in the healthcare law -- the Affordable Care Act (ACA) -- are kicking in, which is further complicating matters.
Breakdown of U.S. Hospitals
According to the American Hospital Association (AHA), there were 5,795 registered hospitals in the U.S. in 2009. The vast majority -- 5,008 -- were community hospitals. Of these community hospitals, 58 percent were not-for-profit organizations, 20 percent were for-profit organizations and 22 percent were state and local government community hospitals.
Keeping that in mind, below are nine of the main factors that might affect valuations of hospitals. For purposes of this article, we focus on general acute-care hospitals. Different standards may apply to other types of hospitals -- such as long-term acute-care, rehabilitation, critical access, psychiatric and specialty surgical hospitals -- that aren't addressed here.
- Geographic location - As with residential homes in the real estate market, one could argue that the three main factors in valuing property are "location, location, location." A hospital site in an affluent area will likely have a high percentage of commercial insurance patients, which increases profitability. Also, if it is easily accessible to the public, the hospital may produce a high patient volume. Conversely, hospitals in remote areas are generally less attractive to patients.
- Facility condition - Of course, you can't "judge a book by its cover," but the appearance of a facility is important in valuations. A modernized facility -- especially as it relates to equipment, capital improvements and other technologically-based functions -- is favored by physicians and investors. Conversely, a rundown-looking facility detracts from the value.
- Medical staff - Another true axiom is that a business is only as good as its employees. Hospitals are no different. The composition of the staff -- including employed and privileged physicians -- is integral to the operation. Note the recent trend toward employment of physicians by hospitals. According to the Medical Group Management Association, 68 percent of the respondent physician practices were hospital-owned in 2010, compared to just 26 percent in 2005.
- Competition - What is the competitive marketplace like? Traditionally, this was restricted to other hospitals in the area, but now there are more competitors such as physician-owned hospitals and ambulatory surgery centers, which provide outpatient surgical services to patients who don't require hospitalization. Due to technological advancements, physicians can now perform complex surgical procedures in an ambulatory surgery center. Other outside resources may be available to patients.
- Community demographics - This is related to location (#1). Typically, a hospital in an area with high density of senior citizens tends to have a higher value. Naturally, an affluent area is also beneficial for valuation purposes, while hospitals in lower socioeconomic areas usually have more Medicaid and uninsured patients.
- Community support - Because community hospitals are often publicly owned or supported, capital projects may be funded through taxpayer dollars. If a hospital has a reputation for providing substandard service, funding might dry up.
- Insurance contracting - The local commercial insurance market also affects the negotiated reimbursement amounts for hospitals. For instance, a hospital with a large market share in a community can potentially pocket bigger reimbursement amounts from commercial payers. On the other hand, when a single commercial insurer monopolizes a particular market, hospitals have more difficulty negotiating higher rates. This can be a vital factor in the valuation process.
- Economic conditions - For years, hospitals were considered recession-proof, but recent economic trends have proved otherwise. One major problem in the health care industry is the increase in the percentage of uninsured Americans. According to the Kaiser Commission on Medicaid and the Uninsured, the number of uninsured people who were not elderly in the U.S. jumped from 43.4 million in 2007 to 49.1 million in 2010. Hospitals have experienced increases in bad debts, reductions in charitable contributions and slow admissions growth, fueled by patients delaying medical care. Other negative economic factors may come into play.
- Reporting requirements - New purchasing requirements have increased the administrative and reporting burdens on hospitals. To accurately report data to outside payers, hospitals must diligently track and document patient outcomes. In many cases, this requires additional provider documentation to capture information, leading to increased administrative costs. Other changes in the coding system used by health care providers to submit claims for reimbursement have caused significant investments in infrastructure.
This list is by no means all-inclusive. As previously mentioned, the new health care law provisions taking effect will have a dramatic impact. Just like other industries, hospitals are subject to the economic environment around them. Finally, a plethora of laws and regulations govern and define fair market value for the health care industry. All of these are critical factors that are generally reflected in hospital valuations.