Are Nonprofit Hospitals Profitable?

A look into hospital system financials, tax-exempt status, and 340B

tl;dr:

• Nonprofit hospitals are exempt from taxes and receive many other financial subsidies such as access to tax-exempt bonds, 340B drug pricing discounts, and government funding. In exchange, they are expected to provide benefits to their communities.

• While some nonprofit hospitals rely on these subsidies to stay afloat, others — often large hospital systems — already generate substantial profits from operations, leading researchers and policymakers to question the need for subsidies.

• For example, the contentious 340B program allows designated hospitals to obtain medications from pharmaceutical companies at substantial discounts while billing insurance for the full price of the drug. Critics say that some nonprofit hospitals are unfairly taking advantage of the program.

• Establishing requirements for how nonprofit hospitals use financial subsidies and increasing transparency in their financial reporting could help to identify those hospitals most in need of subsidies and ensure subsidies are deployed to maximize societal benefit.

• That many nonprofit hospital systems are operationally profitable — contrary to the standard narrative that nonprofit hospitals typically struggle financially — represents a market opportunity for businesses adding value to hospitals.

Overview

There is a common perception that nonprofit hospitals typically are not profitable, or that they wouldn’t be able to make ends meet without their tax-exempt status. The Gist recently reported that 53% of U.S. hospitals posted a negative operating margin in 2022, higher than any other time in the last 30 years. While financial sustainability is clearly an issue for many hospitals, there are also nonprofit hospitals — often larger systems — that are financially thriving.

Lately, nonprofit hospitals are coming under increasing public scrutiny for their financial management and the impacts to patient care. The New York Times Profits Over Patients series chronicles recent stories of large nonprofit hospital systems slashing staffing to unsafe levels and hounding patients to pay for care that should have been free. A galling 2022 article describes a large nonprofit hospital system maintaining a presence in impoverished neighborhoods, where it provided unconscionably low-quality care, to qualify for the federal government’s lucrative 340B drug pricing program (more on this below). This system made ~$1B in profits, had >$9B in cash reserves, and saved at least $440M in federal, state, and local taxes due to its nonprofit status in 2021. On top of this, nonprofit hospitals are notorious for compensating their executives highly – for example, Montefiore Medical Center, the Bronx-based hospital system known for predominantly serving low-income patients, compensated its CEO over $8M in 2021, a year in which the system lost $60M on $277M in revenue.

This raises the question of how financially strapped large nonprofit hospital systems really are and what drives their financial challenges. Better understanding this can help to shape public policy such as the CARES Act and other federal funding allocated to support nonprofit hospitals, contentious programs such as 340B, and, in the innovation ecosystem, startups’ business models and sales efforts to hospitals.

Nonprofit Hospitals: An Overview

Of ~5,000 hospitals in the U.S., 57.7% have nonprofit status. (The remainder are a mix of for-profit and government-run hospitals). In addition to being exempt from paying most federal and state taxes, nonprofit hospitals can issue tax-exempt bonds and receive tax-deductible contributions. In exchange, they are expected to provide a benefit to their communities, although the IRS has not established quantitative requirements for these benefits. 

We typically think of nonprofit hospitals making money from delivering patient care, but many actually generate revenue from a plethora of other sources. This can include federal funding for running residency programs, state run uncompensated care pools, premium revenue from running their own insurance plans, research grants, patents for drugs they contributed to developing (e.g., Mass General Brigham’s drug portfolio), investment income, joint ventures, and, of course, donations. Within care delivery, McKinsey reported in 2022 that nonprofit health systems are increasingly diversifying beyond acute care with the goal of improving financial performance.

Profits for Nonprofits

In recent years, nonprofit hospitals’ financial losses have been publicly contextualized within a narrative of lower case volumes and higher labor costs since the onset of the COVID-19 pandemic. These challenges seem to disproportionately impact solo operators or small health systems. However, a Health Affairs analysis earlier this year found that 10 top nonprofit hospital systems – which tend to have more diversified revenue streams and stronger balance sheets – had losses that were almost entirely driven by poorly performing investments rather than by patient care operations. 

Furthermore, some hospital systems have remained consistently profitable despite pandemic-related pressures. For example, when I was working at Mount Sinai in 2021, the system generated $185M in operating profit and $396M in net profit, including $86M in CARES Act funding.¹ (This may come as a bit of a surprise to hospital system employees, who were receiving messaging about hiring freezes and financial austerity).

In fact, while nonprofit hospitals in general are comparatively more likely to offer unprofitable services than for-profit hospitals, reporting suggests that some nonprofit hospitals are often more profitable than for-profit hospitals. Nonprofits’ tax-exempt status plays a key role here.

Nothing Is Certain Except Death and Taxes

Nonprofit hospitals are exempted from $30B in taxes each year according to Yale professor Zack Cooper, who has questioned the benefit of these subsidies.² A study of 1,472 hospitals from 2011-2018 found that 38.5% of non-profit hospitals did not provide more community benefit and 86% did not provide more charity care than the value of their tax exemption.³ A June 2023 Health Affairs article study of 2,783 hospitals (2,219 nonprofit and 654 for-profit) found that increases in profit at nonprofit hospitals were not correlated with increases in charity care, but were correlated with increases in cash reserves.⁴

Exhibit from June 2023 Health Affairs Article

Why do hospital systems care about building up their cash reserves? The Health Affairs study suggests cash reserves help with covering capital costs and unexpected shortfalls in payer reimbursement, and with earning higher bond ratings, which lowers organizations’ cost of capital (i.e., makes it cheaper to take out debt). 

While it seems unlikely that tax breaks to hospital systems will be revoked anytime soon, researchers have suggested ways to nudge these dollars toward community benefit, such as publicly ranking hospitals based on their community benefit or charity care. The IRS could also establish minimum requirements for nonprofit hospitals to invest in these areas, including related to 340B.

To (340)B Or Not To B

One increasingly contested source of profits for nonprofit hospital systems is the 340B program.

The program allows hospitals  (“covered entities”) that care for low-income and uninsured people to obtain medications from pharmaceutical companies at a discount – thought to be at least 25% off the list price according to a 2023 NEJM article – for all patients (not just those that are low-income or uninsured). Hospitals can charge patients’ insurance a higher price for the medications and pocket the difference. The 340B program was established in 1992 with the expectation that hospitals would reinvest the profits into their facilities to improve care for poor patients. According to The Commonwealth Fund, the number of covered entities has grown enormously from 8,100 in 2000 to ~50,000 in 2020 and the amount of purchases under the program grew to $44B in 2021, up 16% from the prior year. 

Who knew that all along Kanye was dropping wisdom on 340B?

340B has become a bit of a spicy topic. For one, the program has led to some unintended consequences for patient care. For instance, since hospitals are seeing decreasing profits from 340B on infusion drugs purchased via outpatient departments, they are financially disincentivized to deliver medications via home infusion, which can be more convenient and comfortable for patients. 

Furthermore, since 340B requires pharmaceutical companies to sell drugs to covered entities at below-market prices, many pharma executives view 340B as an unfair subsidy to hospitals. I recently heard the CEO of a large pharmaceutical company assert that hospitals are taking advantage of the program to generate profits that aren’t used for their intended purpose. (Unsurprisingly, the American Hospital Association has a very different take on this). In 2021, there was an estimated $49.7B difference between drug list prices and their 340B prices – in other words, pharma companies forwent nearly $50B in profits as a result of the program. Pharma industry leaders argue that these dollars could have been used to invest in R&D for new life-saving medications; they are actively lobbying government to reform the 340B program and have successfully imposed some restrictions on it. It is logical that pharmaceutical companies, which operate in public markets and therefore are subject to pressure from investors to grow revenues and earnings, see 340B reform as an attractive opportunity to sell their products at higher prices.

Since nonprofit hospitals share much less financial information than publicly traded for-profit companies, it can be difficult to measure the financial impact and importance of 340B for specific hospitals. According to the American Hospital Association, critical access hospitals (small hospitals in rural, underserved areas) and disproportionate share hospitals (those serving a disproportionate population of low-income individuals) have lost, on average, $500k and $3M annually, respectively, due to recent 340B restrictions. But stories like the aforementioned NYT expose suggest at least some hospital systems are not using 340B for its intended purpose. If 340B funds were truly put towards bolstering healthcare services for those in need, the program could have real societal benefit. One way to drive the intended impact would be to create and enforce specific requirements for how hospital systems use their 340B profits.

Conclusion

In short, nonprofit hospital systems aren’t necessarily unprofitable. In fact, some generate significant profits, which have led many stakeholders to question some of their funding sources, from tax breaks and federal funding to 340B. The lack of transparency into nonprofit hospitals’ detailed financials, at least relative to public companies, complicates the assessment of such policy questions; enhancing financial reporting requirements could be a good starting point. This could also help to identify and better support struggling nonprofit hospitals that rely on such funding sources to stay afloat.

For startups, financially sustainable hospitals are business opportunities. Companies that create real value for health systems – whether by bolstering hospitals’ predominantly fee-for-service revenue generation models or enabling the transition to value-based care – can gain a foothold, as demonstrated by One Medical’s hospital partnerships comprising $260M or ~25% of revenue in 2022. Less wealthy hospital systems also use vendors, although they may have a stronger ROI orientation and a focus on vendors that can help to reduce expenses. All of this isn’t to discount the reality that hospital systems may be allocating their wealth toward uses other than care delivery innovation (say, building cash reserves, provider group or hospital acquisitions, venture investing, or executive compensation), and that hospital sales cycles and implementation timelines tend to be long and complicated, with heavy IT and security components. As an investor and a patient, however, it is reassuring to see data that many nonprofit hospital systems do have the means to invest behind improving patient care.

Addendum on 10/19/23: The U.S. Senate Health, Education, Labor, and Pensions Committee — which is chaired by Bernie Sanders — is actively seeking to establish requirements for non-profit hospitals to “[offer] charity care at levels consistent with the enormous tax breaks they receive.” The committee’s report is linked here.

Thank you to Sara Rothstein for helping me to learn about this topic and providing feedback on this post!

1. Source: Mount Sinai 2022 Consolidated Financial Statements in DacBond (you may need to create a free account with DacBond to view the document).

2. In a 2016 interview, Cooper said, “My instinct is that [the $30B] goes to the leadership of these hospitals in the form of higher pay and it gets reinvested into the facility, some of which goes to better patient care, some of which goes toward shinier buildings and fancier technology with unclear benefits for patients.”

3. Charity care is a subset of community benefit. This article lists out the 17 types of community benefit that nonprofit hospitals report on their IRS Form 990.

4. Both of these studies were funded by Arnold Ventures, a billionaire-funded philanthropy that focuses on evidence-based policy solutions to advance justice.