Critical Access Hospitals: Profitability, Barriers, and Alternatives

Introduction to Critical Access Hospitals

This paper examines critical access hospitals (CAHs), their costs, and strategies for increasing their profitability. Specifically, it explains what critical access hospitals are, whether they are profitable, what barriers impede their profitability, and what alternatives to CAHs exist. CAHs came into existence following the passage of the 1997 Balanced Budget Act (BBA). The Act sought to protect citizens in rural areas by increasing access to healthcare services. With its passage, rural hospitals could transform into CAHs, which are characterized by cost-based Medicare reimbursement as opposed to the Prospective Payment System (PPS), which sets a standard amount of Medicare reimbursement independent of actual costs.

As per the provisions of the BBA, CAHs share the following fundamental features: they are located in non-metropolitan areas, are non-profit in nature, are located at least 35 miles away from the nearest general hospital, have a maximum of 25 beds, and limit patients' hospital stays to no more than 96 hours.

Most hospitals in rural areas were unable to cover their operating costs under Medicare's Prospective Payment System and had to close. Li, Schneider, and Ward (2009) report that between 1990 and 1997 alone, approximately 150 hospitals closed due to rising costs and declining revenues. To ensure that citizens in rural areas retained access to care, Congress passed the BBA, which sought to protect rural hospitals by transforming them into CAHs (Li et al., 2009). Under the cost-based system, Medicare reimbursements are made based on a hospital's operational costs rather than at a fixed, predetermined amount (Li et al., 2009). According to Li et al. (2009), rural hospitals are able to receive, on average, $850,000 more in Medicare payments as critical access hospitals than they would have received under the PPS.

The number of allowable acute care beds in critical access hospitals rose to 25 with the passage of the Medicare Modernization Act of 2003 (Li et al., 2003).

Are Critical Access Hospitals Typically Profitable?

Generally, CAHs have higher liquidity and a greater ability to meet their debt obligations as a result of the cost-based Medicare reimbursement system (Holmes, Pink, & Slifkin, 2006). One challenge of the PPS was that it forced hospitals to lose money on Medicare patients because Medicare paid only a standard reimbursement amount (Holmes et al., 2006). According to Holmes et al. (2006), the immediate effect of conversion was higher profitability, higher liquidity, and a greater ability to settle debts for most CAHs. In a study measuring the profitability of 747 CAHs, Holmes et al. (2006) found that over 60 percent reported an increase in total margins, 63 percent reported improved cash flows, and 62 percent reported improved debt coverage in the year immediately following conversion.

However, sources contend that the profitability of CAHs has been declining over the years due to increasing costs (Holmes et al., 2006; Li et al., 2003). According to Li et al. (2003), CAH costs began to grow immediately after conversion, with operating expenses growing by an average of 1.76 percent in the first year, 2.08 percent in the second year, and 4.94 percent in the third year. A report by the Flex Monitoring Team, generated from a survey conducted in 2021, showed that on average CAHs had a net profit margin of 5.41 percent (Flex Monitoring Team, 2022). A good net profit margin is considered to be at least 20 percent; therefore, a margin of 5.41 percent is notably low (Flex Monitoring Team, 2022). The falling profitability is attributable to several factors discussed below.

Barriers to CAH Profitability and High Costs

First, despite increasing costs, not all costs are eligible for coverage under the Medicare cost-based system (Center for Healthcare Quality and Payment Reform, 2021). Not all services offered by CAHs qualify for cost-based coverage. For instance, ambulatory services are not eligible for cost-based coverage, meaning the hospital receives only standard Medicare payment for those services (Center for Healthcare Quality and Payment Reform, 2021). Furthermore, even for eligible services, not all associated costs may be covered. For example, the time a physician spends waiting for patients may be an eligible cost, but the time spent attending to the patient in the emergency department is not (Center for Healthcare Quality and Payment Reform, 2021). Thus, an increase in costs does not automatically translate into increased reimbursement for CAHs.

Second, the only costs eligible for reimbursement are those that relate to Medicare patients (Center for Healthcare Quality and Payment Reform, 2021). Within each eligible service line, Medicare uses a formula to determine the fraction of costs attributable to Medicare patients. If 5 percent of services delivered in an eligible service line were administered to Medicare patients, Medicare will pay only 5 percent of that service line's eligible costs (Center for Healthcare Quality and Payment Reform, 2021). Costs attributable to non-Medicare patients will not be covered, even when the cost of service exceeds their health plan's payment (Center for Healthcare Quality and Payment Reform, 2021).

Third, the amount Medicare reimburses is reduced by the cost-sharing amount the patient covers (Center for Healthcare Quality and Payment Reform, 2021). Before Medicare covers the cost of a service, beneficiaries must meet a deductible and co-insurance for outpatient services. The amount Medicare ultimately pays therefore excludes this cost-sharing portion, which the hospital must obtain directly from the patient. Rural hospitals often charge more than what Medicare pays, implying a higher cost-sharing obligation as well (Center for Healthcare Quality and Payment Reform, 2021). Many Medicare patients in rural areas lack supplemental insurance to cover their share of the cost. If these patients cannot meet their cost-sharing obligations, Medicare covers only 65 percent of the resulting bad debt rather than the full amount (Center for Healthcare Quality and Payment Reform, 2021).

Finally, the amount of Medicare payment has been further reduced through sequestration rules (Center for Healthcare Quality and Payment Reform, 2021). The BBA originally set the Medicare payment at 101 percent of eligible costs. However, sequestration rules have reduced this percentage, and hospitals now typically receive only 99 percent of eligible costs (Center for Healthcare Quality and Payment Reform, 2021).

The fundamental barrier to profitability is low patient numbers (Joynt et al., 2011). Patients requiring specialized care may avoid CAHs due to concerns about quality. Critical access hospitals are not required to report to the Hospital Quality Alliance Program or the Joint Commission Performance Measure Program, which means there is limited comparative data for assessing the quality of care they provide (Joynt et al., 2011). Additionally, CAHs have fewer healthcare providers and specialists than hospitals in metropolitan areas, and their more limited access to capital makes it difficult to deliver consistently high-quality care (Joynt et al., 2011).

These low patient numbers mean that CAHs must spread their fixed costs over a small patient base, which drives up per-capita costs (Lee, 2019). Furthermore, the shortage of specialists and limited capital investment restrict the range of services these hospitals can offer, preventing cost savings through economies of scope. As a result, critical access hospitals fail to achieve either economies of scale or economies of scope (Lee, 2019).

An additional factor driving high costs may be moral hazard. Because Medicare reimburses CAHs on a cost basis, there is a possibility that facilities could incur unnecessary costs knowing those costs are eligible for reimbursement — a form of moral hazard in which the party protected from the full financial burden of its decisions has less incentive to control spending (Lee, 2019).

Conclusion

In conclusion, CAHs serve a crucial role in rural areas by ensuring that rural communities have access to healthcare services. However, they are highly inefficient, as indicated by their high costs relative to the small number of patients served. This paper recommends that CAHs be replaced by community outpatient hospitals, which would serve more patients at relatively lower costs. Three key takeaways from this analysis are:

References

Cai, H., Spreckelmeyer, K., Zilm, F., Medina, M., Sheward, H., & Sanguinetti, P. (2017). Exploring alternatives for critical access hospitals: A research-based design for rural hospitals. Architecture of Complexity. Retrieved from https://www.brikbase.org/sites/default/files/ARCC2017_Session2B_Cai_Spreckelmeyer_Zilm_Medina_Sheward_Sanguinetti.pdf

Center for Healthcare Quality and Payment Reform. (2021). Strengths and weaknesses of cost-based payment. Retrieved from https://ruralhospitals.chqpr.org/Cost-Based_Payment.html

Flex Monitoring Team. (2022). CAH financial indicators report: Summary of indicator medians by state. Flex Monitoring Team Data Summary Report, No. 33.

Holmes, M., Pink, G. H., & Slifkin, R. T. (2006). Impact of conversion to critical access hospital status on hospital financial performance and condition. Flex Monitoring Team, Policy Brief No. 1.

Joynt, K. E., Harris, Y., Orav, J., & Jha, A. (2011). Quality of care and patient outcomes in critical access hospitals. JAMA, 306(1), 45–52.

Lee, R. H. (2019). Economics for healthcare managers (4th ed.). Riverside, CA: American College of Healthcare.

Li, P., Schneider, J. E., & Ward, M. E. (2009). Converting to critical access status: How does it affect rural hospitals' financial performance? Journal of Healthcare Organization, Provision and Financing, 46(1), 46–57.