The first discussion point on our Spring 2025 Rating Agency Webinar was the potential reduction in Medicaid funding; specifically, how limiting state directed payment programs (SDPs) might impact ratings. Since 2017, numerous states have established SDPs, which provide supplemental funding to help close the gap between Medicaid reimbursement and a hospital’s cost of care. SDPs are complex in their funding structures, but in their simplest form, the programs are indirectly financed by providers (e.g., provider taxes, intergovernmental transfers). The state then receives matching monies, as determined by statutory constraints, and which vary by state. These funds are then used to offset the low reimbursement rates to healthcare providers.
As discussed on the webinar, many hospital ratings have been affirmed over the past year, in part due to the receipt of sizable SDP funds. In some instances, SDP funds represent a significant percentage of – if not the entire – bottom line.
Without SDP funds to subsidize losses incurred under Medicaid, hospital margins and absolute cash flow will be materially lower, begging the question: What will happen to ratings if the SDP funds decline or abate?
The analysts noted that they are in constant communication with their state rating colleagues. States may respond differently to federal cuts, depending on their financial bandwidth to increase the Medicaid budget, which is already a state’s largest expenditure. According to the National Association of State Budget Officers, Medicaid was the largest state expenditure at 29.8% in 2024, followed by K-12 funding at 18.9% in 2024. It will be up to each state to determine how they will manage any reduction: Will they continue current benefits by funding the gap or reduce benefits to enrollees? Will they introduce work requirements, which may reduce enrollment? Given the enormity of the federal funds and other state budgetary pressures, it seems highly unlikely that states would be able to fully compensate for a federal reduction. A state’s actions will, in part, inform rating decisions.
That said, the three rating agencies largely had a shared response: Each rating will be reviewed on its own merits as they were throughout Covid. They do not expect large swaths of ratings to be put under review but could do so if needed. Sector outlooks, which are currently Stable (Moody’s and S&P) and Neutral (Fitch), could be revised to negative before individual rating actions are taken. To that end, rating agencies are constantly reviewing individual key financial metrics, such as days cash on hand and cash to debt and computing the reliance on supplemental funds for cash flow to triage the portfolios.
Planning for a reduction in Medicaid funding or SDPs is different than during the early days of Covid. At that time, hospitals had never faced a pandemic of that magnitude. Despite the unknowns, higher-performing hospitals (of all sizes and rating categories) provided estimates of low, medium and high penetration-rate scenarios with expense reductions that would be enacted to mitigate the financial impact (such as furloughs, layoffs and supply mitigation steps for masks, gloves and ventilators). There were also strategies around immediate cash preservation that included reductions in capital spending, draws on lines of credit and a greater focus on revenue cycle.
It wasn’t perfect. It was the classic analogy of changing a tire while driving a car. But analysts were able to glean which organizations had some semblance of a plan and it made a difference. Uncertainty often translates into rating pressure, yet ratings were affirmed during the initial Covid period, even before the CARES Act funding was received.
Today’s situation is different. Hospitals should be able to compute how various scenarios will impact margins and covenants. The tools available today to understand cost structure continue to improve, so there should be greater accuracy in understanding the impact, than, say, after the Balanced Budget Act of 1997, when many in the industry underestimated the financial impact. Understanding the knock-on effects is important too. For example, if Medicaid funding is reduced, will hospitals on the 340B bubble no longer qualify for the discounts? We would suggest now is the time to begin developing those scenarios and a new long-range financial plan.
Here are three steps a management team should take when meeting with rating agencies over the near term regarding the potential reductions in federal funding:
- Acknowledge the potential challenges and discuss how your organization will be impacted. Cast a wide net and discuss the myriad of potential reductions and how they will impact the organization including tariffs, NIH funding, loss of tax-exemption and site neutrality. Let them know you are considering all potential changes.
- Share your financial plan with the analysts and the assumptions behind the plan. Identify the strategies to mitigate the impact as during Covid. Understand covenant definitions and revisit them to assess likelihood of compliance. This will build credibility with the analysts and give them the sense that the organization is planning for the “what if’s,” even if they are still unknowns.
- Review cash forecasting strategies and dust off the liquidity playbook. Know your access-to-liquidity strategy. During the webinar, the rating analysts agreed with our statement that cash is the “ultimate mitigant.” Once again, cash buys an organization time, and undoubtedly, the demands on liquidity will grow as Medicaid funding declines. Developing a thorough analysis that identifies daily, monthly and annual cash needs to match your organization’s liquid resources (what we call Strategic Resource Allocation) to those needs is paramount.
Hospitals are seasoned in managing through financial shocks. In this case, management teams have some runway to plan for the financial challenges that may be ahead. Taking action now to prepare, including identifying the steps that could help mitigate the impact, will help build confidence with board members, local communities, rating analysts, investors and other stakeholders.
