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Headline risks abound for not-for-profit hospitals, but credit performance remains solid

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Bill Delahunty, CFA, Director of Municipal Research, Eaton Vance Management and Lilly Scher, Senior Municipal Analyst, Eaton Vance Management

      Boston - As the 2020 election cycle gains momentum, both political parties are pushing proposals that would negatively impact not-for-profit hospital credit quality.

      On the Democratic side, Bernie Sanders, and many other Democratic candidates, are pushing "Medicare for All," which would transition everyone out of commercial and managed care health plans and into a government-run Medicare plan. If this plan were to pass, it would devastate the hospital industry, as it is estimated that hospitals need to be paid 20% more than the Medicare rate to make their business viable.1 However, we think that there is a very low likelihood of this plan passing for numerous reasons including:

      1. Cost: The Medicare program is expected to run out of money in seven years, and the "Medicare for All" bill proposed by Bernie Sanders would cover more people and provide even more services than traditional Medicare. Medicare spending accounted for 14% of total federal spending in 2018 and it is expected to increase to 18% of the budget by 2028, according to the Kaiser Family Foundation (KFF). At a time when the federal government is running a $1 trillion deficit, the cost of a "Medicare for All" will be a major obstacle to the program passing.

      2. Low Republican Support: Even if the Democrats maintain the House and win the Presidency in 2020, there is currently less than a 33% chance they will gain a majority in the Senate.2 The only way "Medicare for All" passes is if the Democrats control all three branches of the federal government.

      While the Democrats are looking to expand government-run healthcare, President Trump continues his efforts to reduce the federal government's role by attempting to dismantle the Affordable Care Act (ACA). The main tenants of the ACA expanded access to health insurance, as evidenced by the fact that the uninsured rate fell from 18% pre-ACA to just 13% in December 2018. This has been very beneficial to not-for-profit hospitals, as it has increased patient utilization and decreased charity care.

      A lawsuit brought before a Federal District Court by 20 Republican governors who favor ACA Repeal will be heard later this summer. Pending the outcome of the rulings, the case eventually could move to the Supreme Court where precedent to uphold the ACA has been already established and therefore, the likelihood of repealing the ACA by judicial means is extremely thin. We believe that President Trump's best chance to repeal the ACA was prior to the 2018 elections when the Republicans controlled all three branches of government. For now, the ACA (minus the insurance purchase mandate) remains the law of the land.

      Aside from legislative risk, hospitals face a number of additional headwinds, including:

      • Deteriorating payor mix: The percent of revenues derived from government payors that do not cover the cost of care is increasing.3

      • Higher wage, benefit and pharmacy expenses are exerting escalating downward earnings pressure.4
      • The expiration of a law5 that provides extra federal supplementary dollars to those hospitals that treat a disproportionate number of Medicaid and indigent patients.6

      Many hospitals have responded to these pressures by merging operations with other hospitals/health systems (among other health care related entities) in order to increase their scale of operations. The goals of these mergers are to increase efficiencies, increase access to capital, enhance service offerings and benefit from better payment contract negotiations with insurers. In addition to good investment returns that have buoyed balance sheets, mergers combined with the ACA law's favorable insurance coverage impact have figured prominently in the sector's financial improvement.

      The ratios below come from the Moody's rated universe of not-for-profit hospitals, and the charts show that hospitals are much stronger today than they were when the ACA was signed into law in 2010.7

      Blog Image Muni Hospitals May 6

      Source: Moody's, as of 12/31/2018.



      Accordingly, we believe that hospitals are in position of strength to weather upcoming headwinds.

      Bottom line: The hospital sector will be subject to numerous headlines throughout the 2020 election cycle. However, at this point we view both the enactment of "Medicare for All" and repeal of the ACA as low-probability events. Further, while hospitals' operating pressures (listed in the three bullet points above) could impact profitability going forward, the majority of hospitals are starting from a position of strength and we believe they will be resilient and may remain an important contributor to investment performance in muni portfolios.