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Strategic Health Care Trends
November 14, 2006
2
Environmental Trends Over Next 3-5 Years
Payment Sources Under Pressure
Slowing and Shifting Demand
Quality and Patient Safety Initiatives
Increasing Competitive Forces
Resource Constraints—Capital and Labor
Escalating Headline Risks
3
Government Payors: Federal Payment Sources under Pressure
$767$706$649$600$562$529$497$468$438
$342$309
$0
$200
$400
$600
$800
$1,000
2004A 2005E 2006E 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E
Est.
US
Gov
't Sp
endi
ng .
($ in
bill
ions
)
CAGR = 9.5%
Source: 2005 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds
Estimated Increase in US Government Medicare SpendingEstimated Increase in US Government Medicare Spending
Source: Medicare Board of Trustees 2006 Annual Report
0%
2%
4%
6%
8%
10%
12%
1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080
Premiums
Payroll Taxes
General Revenue
Total Expenditures
State Transfers
Tax on Benefits
HistoricalHistorical EstimatedEstimated
HI Deficit Total Non-Interest Incom
e
Medicare Expenditures and NonMedicare Expenditures and Non--Interest Income by Source as % of GDPInterest Income by Source as % of GDP
4
Medicaid Expenditures: A Growing Component of States’ Budgets
Medicaid22.5%
Elementary & Secondary Education
21.9%
All Other31.3%
Transportation8.1%
Corrections3.4%
Higher Education10.8%
Public Assistance2.0%
…States’ medicaid expenditures have nearly tripled over the past 20 years and are expected to reach 27% of total state expenditures by 2010, representing one of the largest components of State spending.
Source: NGA/NASBO Fiscal Survey, December 2005
Total State Expenditures by FunctionFY20051
8.0%
13.0%
20.0% 20.0%22.5%
27.0%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
1985 1990 1995 2000 2005 2010(Projected)
Source: Vernon Smith, Health Management Associates
Medicaid Expenditures as a Percent of Total State Spending
5
The Emerging Reality of Provider Payments
56% of payments for health care services are channeled through private payors. Growth in this segment will accelerate with increasing penetration of Medicare Advantage.
Approximately 300 million people Approximately $1.6 trillion in payments
$100 billion not paid$45 billion self-pay
$6 billion from Federal government
$325 billion CMS & States
$100 billion individuals
$400 billion CMS
$250 billion self funded
$400 billion insured plans
$ Paid by Sources: In Practice
Source: Citigroup reports and Citigroup Investment ResearchNote: Managed Care Orgs (in pie chart) include Commercial Insured, Self-Funded Employers, Medicare Advantage and Medicaid Advantage)
Population $ Paid by Sources: In Theory
Approximately $1.6 trillion in payments
Individuals47 million uninsured
TriCare: 3.7%Military & Veterans
Medicaid: 15.6%Indigent & children
Medicare: 13.7%Age 65+
or disabled
Commercial : 46.7%Covered by employers
Commercial Insurers: 40.0%
Medicare: 30.8%
Medicaid: 20.0%
Other: 6.2%
56%
22%
7%
0%9%
6%
Managed Care Orgs $906.8 billion
CMS (Medicare) $352.0 billionCMS & States $120.3 billion
Federal Government $2.0 billionIndividuals $145.0 billion
Not Paid $100.0 billion
6
Commercial Payors: Payment Sources are Increasingly Driven at National Levels
$45,136 $45,365
$6,470
$14,395
$31,120
$16,684
$22,492
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
Aetna Cigna Kaiser WellPoint United
2005
E R
even
ues
($ M
illion
s)
WellPoint (the Blue)
• Combined enrollment of 34 million members
• Operates as Blue Cross or Blue Shield license in 14 states; #1 ranked in 12 states
Pacificare
United (the non-Blue)
• Combined enrollment of 23 million members
• Operates nationally as the largest health benefit provider
Commercial Insurance is Increasingly Driven by Two Super Insurers
WellChoice
Total = $51,606
Total = $59,760
Source: Source: Wellchoice and Pacificare data based on Thomson First Call Consensus FY2005 estimates. Others based on FY2005 audited financials.
7
Quality and Patient Safety Initiatives
Clinical and information technology investment
Workforce development and training
Process flow redesign
Facilities design
Payor focus
Impact of transparency
8
High Investment in Technology
23.0%
25.0%
33.9%
34.6%
34.6%
34.8%
36.1%
37.2%
49.6%
50.7%
61.3%
64.1%
71.7%
0% 10% 20% 30% 40% 50% 60% 70% 80%
New hospitals
Renovate to accommodate computers in patientrooms
Expand outpatient facilities
New outpatient centers
Increase lab space
Increase bed capacity
Convert semi-private rooms to private
Add specialty unit
Increase OR Capacity
Increase ER capacity
Purchase major IT/information system
Purchase computerized physician order entrysystems
Purchase digital radiology systems
“Executive management must embrace IT as a cost of doing business and a way of transforming the organization to ensure its viability. While ‘return on investment’ remains a critical factor for deciding some IT investments, it cannot become the sole factor in determining the value of IT on service quality or outcomes.”
- HIMSS Analytics
The top 3 forecasted
categories of capital
purchases over the next 5
years are related to
information technology.
Source: HFMA, Financing the Future, Report 6
Planned Capital Purchases, Next Five Years
Technology-related
Capacity-related
Other
9
Increasing Competitive Forces: Pure Play Companies
Pure Play Companies peel away high margin businesses
10
The Lifting of the Specialty Hospital Moratorium
Economic incentives re-aligned via reimbursement changes to payments
Physician conflict of interest resolved via financial disclosure
Federal response was to change the economic incentives for specialty-hospitals, in effect “leveling the playing field” and enabling increased competition
November 2003
June 2005
August 2006
Congress instructs CMS to prohibit physician-investor referrals to specialty hospitals for a period of 18 months
The 18-month moratorium period ends. Investigation continues.
CMS issues its final report to Congress and allows the
moratorium to officially expire
STOP CAUTION GO
11
Resource Constraints: The “Capital Gap”
Capital access will
become tighter for all health care providers, particularly
so for marginal credits. Technology and Delivery Innovation
Reconfiguration of Physical Assets
Product/Service Portfolio Rebalancing
Physicians
Key Uses of Strategic CapitalKey Uses of Strategic Capital
Operations
Financing
Investments
Philanthropy
Sources of Strategic CapitalSources of Strategic Capital
The Capital Gap
Capital Partnerships & Asset Sales
Routine Capital Ambulatory Clinics
New Beds
Devices IT
Surgical Suites
Niche Facilities
Source: Citigroup / Tiber research
12
Resource Constraints: Growing Labor Gap
Number of Retiring Workers & New Entrants1
(in thousands)
-2,000
-1,600
-1,200
-800
-400
0
400
800
1,200
1,600
2,000
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Shortfall Newly Retired New Entrants
Source: Federal Reserve Bank of Atlanta, The Health Management CEO Forum, August 20051 New Entrants = Newly Employed Aged 16 to 24
13
Unsustainable Business Fundamentals
Rising Constraints: Capital & Labor
Payer
Consolidation
Growth of the Uninsured
A variety of pressures on health care providers are anticipated to “squeeze” underlying business fundamentals over the next 3-5 years
Provider
Slowing & Shifting
Demand
Constrained Payment Sources
Quality & Patient
Safety Imperative
Increasin
g
Competitive Force
s
Escalating Headline Risk
14
Evaluating Health Care Provider Performance: Data Base Includes Approximately One Quarter of All U.S. Hospitals
> $3 Billion8%
$1-3 Billion32%
< $1 Billion60%
Total Systems
Single-State Systems
Total = 46 systems828 hospitals
(24% of Database)
Total = 145 systems559 hospitals
(76% of Database)
Multi-State Systems
Total = 191 health care systems(1,387 hospitals)
> $3 Billion
2%$1-3
Billion28%
< $1 Billion70%
> $3 Billion26%
$1-3 Billion44%
< $1 Billion30%
15
2.86%
0.87%1.53%
1.96% 2.39%
3.70%
4.90%5.10%4.60%
0.0%
0.4%
0.8%
1.2%
1.6%
2.0%
2.4%
2.8%
3.2%
3.6%
4.0%
4.4%
4.8%
5.2%
2001 2002 2003 2004 2005
Aggregate Virginia Aggregate
Good News: Operating Margins Improving
Operating Margin
Virginia Aggregate Source: Virginia Health Information Industry Reports
16
Bad News: Margin Growth Across All Size Organizations Has Been at Slowing Rates
Year-over-Year Change in Operating Margin
19.7%
22.2%
76.1%
28.2%
4.08%
32.43%
-19.57%
-40.0%
-10.0%
20.0%
50.0%
80.0%
110.0%
2001-2002 2002-2003 2003-2004 2004-2005
Aggregate Virginia Aggregate
Virginia Aggregate Source: Virginia Health Information Industry Reports
17
-1.0%
1.0%
3.0%
5.0%
FY01 FY02 FY03 FY04 FY05
>$3 B $1B - $3B <$1B Aggregate Virginia Aggregate
While Operating Margins are Improving Overall, Scale of Health Care Systems is Driving the Strongest Results
Operating MarginStratified by Size
228.7%
662.5%249.5%
180.8%
Virginia Aggregate Source: Virginia Health Information Industry Reports
10.9%
18
Scale Drives Lower Supply Costs
Supply Costs: Expense RatioStratified by Size
16.0%
17.0%
18.0%
19.0%
20.0%
21.0%
22.0%
FY01 FY02 FY03 FY04 FY05
> $3B $1 - $3B < $1B Aggregate
-64.9%
-13.7%
-14.7%
3.3%
19
Scale Generates a Cost of Capital Advantage
Total Cost of Debt—Stratified by Size
3.5%
3.9%
4.3%
4.7%
5.1%
FY01 FY02 FY03 FY04 FY05
> $3B $1 - $3B < $1B Aggregate
12.0%
-16.7%
-19.9%
-21.1%
20
Scale may Create a Sustainable Advantage for Health Care Systems
Provider
Achieve Pricing Leverage and
Revenue Diversification
Manage Resource Constraints
Proven Trends:Proven Trends:
Faster Revenue GrowthFaster Revenue Growth
Lower Supply CostsLower Supply Costs
Ability to Pay Work Force MoreAbility to Pay Work Force More
Lower Cost of CapitalLower Cost of Capital
Leverage IT SpendingLeverage IT Spending
21
Another Data Point…Seven Years of Rating Action Show the Advantages of Scale
38.5%
18.4%14.5%
8.6%
33.3%
12.4%
28.3%
7.7%
40.8%
37.3%
46.7%
13.3%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
>$3 B $1-3B $400mm-$1B <$400mm Multi-State Single-State
Downgrades Upgrades
Moody’s Investors Service has divided 250 health systems into the following categories assessing the percentage of downgraded credits for the period of 1998 – 2005
Large health care systems experienced far fewer downgrades
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