Medicaid cuts prompt health systems to boost financial performance
Hospitals that successfully cut expenses and drive top-line growth will improve their positions ahead of coming federal Medicaid cuts.
Health systems’ expected responses to impending Medicaid cuts will likely drive improved financial performance before the cuts start to have large effects in 2027, according to a credit rating agency.
Fitch Ratings’ not-for-profit healthcare sector outlook expects health systems will aggressively undertake a range of cost reductions and revenue improvements that will build on recent solid performance. Those are expected in response to looming Medicaid cuts from the One Big Beautiful Bill Act (OBBBA) that won’t significantly hit providers until 2027.
2025 medians were projected to improve from the 1.1% 2024 median operating margin (purchase required) across Fitch’s rated hospitals and health systems. And 2026 performance was expected to beat that.
“There are plenty of health systems out there who will use this current period as a period of adjustment to accelerate on strategies, both in terms of expense savings and finding ways for top-line revenue growth,” Mark Pascaris, a senior director for Fitch, said in a recent webinar. “So, there’s a bit of the market forcing them to respond.”
Pascaris noted that labor cost increases have slowed but labor has settled at a higher share of expenses than they were pre-pandemic.
“When you are dealing with an industry with very tight margins, you have got to find ways to be even more efficient, more productive on the labor front,” Pascaris said.
Some organizations were expected to use AI and other technology to drive market share gains and improve cash flow, while others will fall behind.
A recent HFMA CFO survey (purchase may be required) found 83% are using AI in some form. However, they remain skeptical that investing in AI will result in an overall cost reduction, with just 39% reporting they expect cost reduction.
When provisions go into effect
There was expected to be wide variation in states’ implementation of OBBBA provisions, such as work requirements. Many health systems contacted by Fitch raised specific concerns about their state’s ability to track whether enrollees are either working, in school or volunteering 80 hours per month.
Other health system financial consequences expected once OBBBA provisions start to go into effect include:
- Increased bad debt
- Increased charity care
- Reduced capital expenditures
- Increased mergers and acquisitions (M&A)
Increased M&A could be driven in the coming years by higher rated health systems looking to strengthen their market position and expand to new markets ahead of the cuts going into effect.
That projection came amid a slowdown in the first half of 2025, when there were only 13 announced hospital mergers, according to data from Kaufman Hall. That is compared to 31 announced mergers in the first half of 2024.
Most adversely affected will be providers in states that aggressively enrolled residents in their Medicaid programs, such as California. Also, the most impacted will be health systems in states that rely heavily on state-directed payment (SDPs) and provider taxes, such as Kentucky and Louisiana.
The largest broad-based hospital-focused SDPs approved by CMS in the runup to the OBBBA’s enactment included:
- $1.5 billion for New Mexico
- $1.3 billion for West Virginia
- $2 billion for Washington
Rural hospitals already struggling heading into this year were expected to fare worse under OBBBA.
Health systems could see a net benefit from the law’s $50 billion rural provider fund if they are in states that have no or small SDPs and provider taxes, some form of existing work requirements or provisions barring undocumented immigrant enrollees.
Further future issues
Federal debt. The OBBBA was expected to add trillions of dollars to the federal debt and annual deficits. That will add to an already “very elevated” debt and annual deficits, he said. That could be an issue for healthcare within five years.
“More and more folks will start to focus in on the federal budget deficit and when they do, it seems like federal healthcare spending will probably be part of the conversation,” Pascaris said.
Coming labor crunch. Fitch projects that health systems will face a significant labor challenge around 2030. That’s the year all Baby Boomers will be eligible for Medicare and when those organizations will face waves of retirements by their own staff in that generation.
