The Impact of the 2008 Economic Recession on U.S. Medical Schools and Related Organizations

Editorial Manager(tm) for Academic Medicine Manuscript Draft

Title: Impact of the 2008 Economic Recession on U.S. Medical Schools and Related

Organizations Article Type: Research Report Corresponding Author: Dr. Jack Krakower, Ph.D.


Corresponding Author’s Institution: AAMC First Author: Jack Krakower, Ph.D.


Order of Authors: Jack Krakower, Ph.D.; Margarette C Goodwin, ?; Heather Sacks, ?; David Hefner, ?


Manuscript Region of Origin: UNITED STATES

ABSTRACT

The near collapse of the U.S. financial system in 2008 had broad impact that did not spare the U.S. health care system, including medical schools and teaching hospitals. Two years later, the media is still filled with reports about schools and hospitals that are struggling to survive. In order to obtain insight into the impact of the financial crisis on academic medical centers, AAMC staff conducted interviews with the leadership of medical schools that purported to experience material losses in funds supporting their organizations.

This article describes the magnitude of the losses reported by participating schools and the factors that should be considered in interpreting their impact. It describes the actions and strategies that schools adopted to address financial stress and suggests steps that might be taken by other schools that find themselves in similar circumstances. It concludes with observations by some interviewees regarding the use of the crisis to bring about needed changes that would not have been possible without a “burning platform.”

An added commentary by a health system president warns against tactical approaches adopted by most schools that fail to address systemic changes required to assure the long-term health of academic medical centers.

BACKGROUND

The collapse of the investment sector in 2008 had widespread national and international impact. Not unlike other economic and health sectors, the fall-out included material losses in critical sources that support medical schools and teaching hospitals in the United States News media began reporting the impact of the losses in the fall of 2008, and by early 2009, furloughs and staff layoffs were reported at universities, medical schools and teaching hospitals across the country.1

The Association of American Medical Colleges (AAMC) determined it would be useful to investigate the targeted impact of the crisis on U.S. medical schools and steps taken to address the situation. This paper summarizes the causes, impacts, and steps some institutions have taken to address problems related to the financial crisis.

In July 2009, AAMC staff contacted Group on Business Affairs (GBA) Principal Business Officers (PBOs) asking those at schools experiencing material revenue reductions attributable to the crisis to participate in a brief phone interview. PBOs from 23 schools agreed to participate in a 30-minute interview. A copy of the interview protocol is included as an appendix to this document.

SOURCE AND MAGNITUDE OF LOSSES

There is no simple way to characterize the magnitude of losses experienced by schools in the study, albeit the sources are generally predictable. The magnitude of losses reported by participating PBOs ranged from those that were described as imminent but never materialized to losses ranging from under $1 million to more than $80 million, with anticipated losses in one school approaching $200 million over the next three years.

To understand the impact of losses at a given school, one needs to understand the funding source(s) affected, intended use(s) of the lost funds, the magnitude of the loss, and the ability of the institution to cover such losses from other funding sources. At some schools, FY09 losses were defined as funds allocated or appropriated that were subsequently unavailable for spending (i.e., budget reductions), whereas other schools defined losses as the difference between budget projections and funds available for spending (i.e., revenue shortfalls). In order to understand the impact of the size/magnitude of a given loss, one also needs to compare current year revenues to prior year revenues for the source in question.

In the descriptions that follow, ―losses‖ include both budget reductions and revenue shortfalls. In some cases, losses may have been covered from alternative fund sources such that existing commitments (e.g., faculty salaries) and planned commitments (e.g., program expansions) were ultimately met.

As might be predicted, reductions in state support was the most common source of material losses for public schools (and even a handful of private schools). Schools, particularly private institutions that relied heavily on investment earnings (e.g., from endowments, quasi-endowments, unendowed reserves and working capital) to support current operations reported experiencing material losses. 1 While media reports have suggested that losses at teaching hospital have been widespread, the majority of PBOs in our sample reported that their affiliated hospitals expected to break-even or end the year with a positive bottom-line.2 Even more surprising to us, the majority of PBOs reported that clinical practice income was at least

However, this strategy was not available to all schools, with several relying heavily on investment income to support current operations. In many of these cases, endowments had been established to support the creation of new faculty positions and research centers. Faced with reduced earnings, the schools found themselves in the position of having to either underwrite these commitments from other fund sources, and/or materially cut other expenses in order to fund these commitments.

Most PBOs with whom we spoke reported losses in no more than two sources – most often state support and investment earnings. Although gift revenues were impacted at many schools, these tend to be relatively small in scope. Furthermore, because gifts are often restricted by the donor, medical schools were not reliant on these funds for day-to-day operations.

Several schools experienced significant losses from multiple sources and found themselves facing dire circumstances due to commitments previously made based on revenue assumptions. These commitments included recruiting new faculty to grow the research enterprise, construction of research buildings and critical, but marginally revenue producing faculty, for clinical programs. This scenario occurred in both relatively small medical schools as well as some of the largest schools in the country. In these circumstances, the coupling of financial losses from multiple sources with the costs of significant new commitments served to create the ―perfect storm.

One of the common refrains we heard from both public and private schools was that the medical school was often viewed by the parent university as the ―fat cat‖ school that could bear a larger share of the budget cuts. It’s easy to envision how those who do not understand the nature of medical school financing might come to this conclusion. The median total revenue for public medical schools in FY 2008 was $424 million; the median for private schools was $651 million. The relatively large size of total revenues characteristic of most medical schools sometimes leads to the erroneous conclusion that cuts of a few million dollars or additional parent taxes on the medical school have relatively little impact on operations of the medical school.4 However, funds available for discretionary spending are but a small fraction of total revenues.5

The principal sources of seemingly ―discretionary funds that support the operations of medical schools are state support (in the case of public schools), unrestricted gifts, endowment earnings, indirect cost recoveries, and tuition. Only a handful of schools also have access to patent income.

Although ―discretionary fund sources represent a fraction of the budget for most medical schools, more often than not, they are the primary source of funding for medical education and medical school administration as illustrated by the circumstances facing one school that participated in the study. In FY08, this school’s total budget was nearly a billion dollars, but state support to the medical school has historically been among the lowest in the country. At the onset of the crisis, state support to the medical school was reduced by one-third. Although the reduction amounted to little more than one-half percent of the school’s total budget, state funds were the primary source of support for medical education, tenured faculty salaries, student services (e.g., financial aid), and medical school administration (e.g., admissions). In this case, the school was able to divert dean’s development funds to cover some of the loss but was unable to cover the entire loss, thus resulting in cutbacks in services and staff.

On the one hand, this example illustrates why it is difficult to characterize the relationship between the magnitude of losses and their effect on a given medical school. On the other hand, we did find patterns between the source of funds cut and the impact. Because state funds are generally used to cover expenses related to teaching and administrative infrastructure, reductions in state funds typically required medical schools to reduce administrative staff in the dean’s office and in departments. The impact on educational programs was less clear because schools took a variety of steps to preserve educational programs as discussed in the next section.

As previously mentioned, some schools relied on earnings from endowments and quasi-endowments to fund key aspects of their current operations. Schools that relied on this funding model experienced material shortfalls due to the loss of investment income.6 These were most often research-intensive schools that made commitments on investment income to hire new faculty and construct new facilities needed to expand their research mission. The loss of investment income meant not only that they could not continue to grow research, but that they were challenged to meet commitments made to new faculty and to fund debt service on new facilities.

While this study focused on reductions in revenues, one PBO pointed out that the other side of the equation is material increases in expenses, particularly expenses associated with compliance, quality assurance, and technology. The school in question had experienced cost increases that exceeded 15% annually for the last six years – all without off-setting sources of revenues.

STEPS TAKEN TO ADDRESS LOSSES

Steps taken to address budget reductions and revenues shortfalls can be characterized as falling into two categories – tactical and strategic. The two approaches are distinguished in terms of the former encompassing short term steps aimed at staunching losses and shoring-up the enterprise whereas the latter approach encompasses longer term actions that seemed to be driven by a more holistic approach to dealing with financial problems. 

While a strategic orientation may have guided the steps schools took to address the budget crisis, most of the actions taken were described in more tactical terms. It should be noted that the degree to which a particular medical school’s leadership participated in making decisions about how to approach the budget crisis varied across schools, so that medical schools that might have otherwise chosen a strategic approach were sometimes partially constrained by tactical steps mandated by the parent university.

The tactical steps offer no surprises – reductions in discretionary expenditures (e.g., travel), hiring and salary freezes, and administrative staff furloughs and layoffs. It was rare that furloughs or layoffs applied to faculty, and when layoffs were required, the dean’s office generally took a proportionately greater share of the burden. Budget reductions were frequently administered across-the-board with the dean’s office and departments sharing the burden; however, at some schools, reductions were distributed across departments based on ―ability to pay.

Other tactical steps taken to address budget reductions and revenue shortfalls included:

 Consolidating basic sciences departments
 Consolidating administrative functions across departments (e.g., IT, grants
management)
 Consolidating administrative functions between the medical school, clinical practice,
and an affiliated hospital (e.g., IT, budgeting, cashier, safety, human resources,
credentialing)
 Increasing tuition and student fees
 Delaying capital projects, thus preserving cash
 Deferring building maintenance
 Changing benefits plans, including retirement contributions
 Eliminating bonuses and position reclassifications
 Implementing clinical performance incentives and clinical workload standards
 Changing faculty compensation – limiting guaranteed salary for tenured faculty
 Developing new clinical service lines in order to increase patient volumes and reduce
expenses
 Consolidating faculty clinical practice plans
 Delaying implementation of strategic priorities (e.g., increasing class size, electronic
medical records)
 Implementing plans to consume less energy
 Implementing ―green initiatives‖ to reduce waste
 Closing regional physician offices and clinics
 Implementing voluntary retirement programs or buy-outs for senior faculty
 Outsourcing services, such as printing
 Delaying chair recruitment and giving greater consideration to internal candidates
 Developing new programs to generate tuition revenues (e.g., post-baccalaureate
certificates)
 Enforcing policies on space utilization and density
 Developing partnerships with affiliate hospitals that result in profit sharing
 Draining reserves?

A number of schools reported that protecting the educational mission influenced their decisions, though generally not in the context of an overall institutional strategy for dealing with losses. Only three of the 23 schools interviewed reported steps the institution took in the context of an over-arching strategic plan. Even when schools adopted a strategic approach, many (if not most) of the steps they took were identical to those of schools whose approach was tactical. However, in these schools, the decision-making process included identifying steps needed to achieve both short-term and long-term organizational goals.

It should be noted that those schools who adopted a strategic approach faced very significant budget reductions and/or revenue shortfalls—in the tens of millions of dollars, but not all schools who faced significant losses adopted a strategic approach. In some cases, the magnitude of budget reductions and revenue shortfalls was both sudden and unanticipated; there was simply no time to develop a process for strategic decision-making.

As described by the PBO at one school that adopted a longer term strategic approach: ―Our overall intention was to change the culture of how people operate at the institution and to have their response be long term and sustainable, even as times got better.‖ This school’s plan included four components. First and foremost, they considered the feasibility of developing and implementing ―more systematic business practices‖ as the ―keystone‖ to long-term cost reductions. As a part of their overall strategy, the medical school partnered with their affiliate hospital in the planning process. The dean and hospital CEO committed to working collaboratively to make the organization a ―high performing, highly reliable organization‖ and to strive for ―resource maximization.‖ The result of their efforts included eliminating and recombining redundant hospital and medical school support/administrative services in areas including purchasing, housekeeping, and capital planning. Other steps included cuts in discretionary spending, educating faculty and staff about the costs of running the school (―reduce, reuse, and re-think‖), taking steps to reduce energy consumption, and reaching out to faculty and staff for ideas to improve efficiency. It should be noted that this was accomplished in the absence of a reporting structure that required the dean and hospital CEO to work together!

LESSONS LEARNED

PBOs who participated in the interviews were asked to describe what they learned from their experience that might benefit other schools facing similar circumstances. Their advice can be organized into three categories: 1) communication, 2) processes, and 3) crisis as an opportunity.

Nearly all of the PBOs with whom we spoke talked about the importance of frequent, honest, and open communications as critical to dealing with the situations that they faced. They spoke about the importance of regular meetings between the dean, chairs, where possible, health system personnel, and ―town hall meetings with faculty and staff. The mechanism for communicating with students, residents, and postdoctoral trainees was not always clear, but many PBOs said that budget news updates were frequently posted on their websites. Even though communication was identified as paramount, significant shortfalls surfaced. Among these was that communications between the dean’s office and chairs did not always filter down to faculty. Equally problematic, messages conveyed by chairs (and sometimes the dean’s office) were sometimes inconsistent.

The second category relates to how the process was managed and how the process materially influenced the success/failure in dealing with the situations they were facing. Advice and observations included:

 Chairs & faculty almost reflexively denied the circumstances facing the institution,
taking a position that the institution could ―ride out the storm.‖
 Even when chairs were involved in deciding how to cut expenses, it was not
uncommon for them to take a position that the cutbacks should not apply to their
department.
 The dean’s office did not always have transparent knowledge of departmental fund
balances.
 Having a consolidated budget process that includes the medical school and the
health system is essential to decision-making.
 If layoffs are necessary, effect them all at once and in unison.
 It is essential to align spending with priorities.
 Small decisions can cause huge ripples.
 Faculty should be directly involved in the earliest stage of the decision-making
process, especially if the magnitude of cuts involves reducing faculty salaries,
departmental reorganization, or other actions that affect them.
 Students should be engaged early in the process.
 Celebrate your successes!

The third category of lessons learned has to do with the notion that a crisis may create opportunities to change the organization in ways that are necessary but might otherwise be extremely difficult to implement. It can be characterized by the expression, ―Never let a serious crisis go to waste (Rahm Emanuel).‖ As noted above, several schools used the crisis they faced as the opportunity to consolidate departments and administrative functions, reallocate resources across departments, restructure compensation, and implement productivity measures and standards. In addition, the crisis provided some organizations with the basis for strengthening the partnership between the medical school, the clinical practice, and affiliated hospitals.

CONCLUDING OBSERVATIONS

The impact of the financial crisis on schools that participated in the study ranged from imminent, devastating cuts that did not materialize to situations that involved material budget and program cuts, staff furloughs, and layoffs. We note, parenthetically, that we did not hear of one instance where a faculty member was laid-off as a consequence of financial stress. Recent conversations with PBOs suggest that many schools continue to operate in a psychological state that is akin to ―waiting for the ax to fall,‖ or living on an earthquake fault-line – even though the financial crisis has yet to seriously impact their organization.  Decision-making and infrastructure conditions that led to the circumstances facing schools seem to cluster into four categories: (1) revenue projections built on the assumption that ―past performance is indicative of future results,‖ particularly with respect to assumptions about the continued growth of the research enterprise and indirect cost recoveries and the growth in endowments and endowment earnings; (2) resource commitments made based on the assumption that increasing investments, particularly in the research enterprise, would result in increased revenues; (3) lack of management systems and accountability mechanisms at both the dean’s office and department levels that hindered the ability of schools to react quickly; (4) dependence on state/parent funds as the sole source of support for education and administrative infrastructure.

Steps taken to address the financial crisis seemed to fall into two overlapping categories: tactical and strategic – with the latter category encompassing responses found in the former category, but including a set of over-arching goals and communications processes that focused on bringing about changes to the entire organization. The crisis forced some schools to confront weak accounting, reporting and management systems, and provided a rationale for introducing greater accountability into their systems. It also obliged some schools to identify and remove artificial political barriers that resulted in duplicative and inefficient systems.

Shrinking resources, particularly with regard to endowment earnings and state budget reductions, forced many schools to turn to short-term tactical solutions such as hiring freezes, layoffs and furloughs. Even as the national economy shows signs of recovery, the impact of financial crisis on medical schools, particularly those who rely heavily on state funds, will likely extend well into FY2011.

Commentary: “Fair Warning” – A Health System Executive’s Perspective

Those of you who have attended auctions may recall that the auctioneer’s cry of ―fair warning‖ to signal bidders that they have one last chance to change the course of events before the gavel falls and the bidding ends. Reading the draft report of this study compels me to offer my own version of ―fair warning‖ to my medical school colleagues. I offer this in hopes that we will jointly recognize and come to grips with the failed notion of incremental reactions as a substitute for an overarching strategic and complimentary tactical multi-year approach for fundamentally redesigning our operating models. My advice is informed by serving as the senior executive of two teaching hospitals and practice plans, as well as serving as a consultant to the leadership of more than seventy-five medical schools and AMCs over the last twenty-five years.

With the near-economic collapse of the financial industry, the rapid decreases of revenues and investment income, and the concomitant recession we are in the midst of, most care delivery institutions restored their margins by dramatically reducing their cost base (see previous reference to the COTH quarterly report).


The financing and feedback loops of hospitals and health delivery enterprises are crystal clear when compared to medical schools. All hospitals are obliged to produce balance sheets and understandable profit/loss statements. Hospitals that fail to generate a sufficient margin, let alone break-even, are subject to severe treatment by external entities such as bond rating agencies and creditors. Hence, the strategic planning and financial modeling processes of hospitals tend to have built-in upside and downside scenarios that enable their leadership to prescribe precipitous actions that preserve the long-term viability of the enterprise.

The financing of medical schools is, at best, characterized as ―one off. While they are commonly supported by only a handful of fund sources (e.g., clinical practice revenues, grants and contracts, hospital support, university overhead, philanthropy, etc.), the interplay of these dollars and the administrative infrastructures vary dramatically. It could be argued that hospitals, unlike their medical school counterparts, are not subject to the same labor constraints with respect to cutting costs — e.g., faculty tenure and due process. However, the external visibilities and stresses of unions, the media scrutiny, and the serving the safety net needs of their communities are similar constraints and trade-offs that lead me to believe we all have our constraints to wrestle with.

A historical and somewhat analogous version of ―fair warning‖ comes from the food preservation industry. In the 1920s, the first patents for refrigerators, then described as a ―refrigerating machine for cooling and preserving foods at home,‖ were issued. The dominate ice cutters’ union in Minnesota dismissed the new fangled machines as dangerous contraptions. Furthermore, they were certain that, at best, all they needed to do in response was to learn how to cut ice more efficiently.

As I read about or witness first-hand the tactical rather than strategic approaches taken by our medical schools, I cannot help but conclude that we are focusing on cutting the ice more efficiently. Taking steps to protect the status quo ignores reality. Unfortunately, there is evidence to suggest that this is not the first time that our schools have chosen to believe that what is happening around us is not applicable. The study done by Heinig, Dickler, Korn, and Krakower in 2007 demonstrated that while the NIH had made it clear that research funding would be flat (at best) in the next 3-5 years, almost all schools in the country reported their expected research portfolios would grow by 3%-5% per year for the same period.7 We see the same gold rush mentality as it relates to the temporary ARRA stimulus funding that wears off in the next 12 months – – have we not just increased our research base and consumption that will inevitably lead to heightened research shortfalls?

I do not for a moment believe that we are out of the economic woods and can continue to operate as we have. If we do not press forward with substantive and systemic change, the likes we have not experienced for 40 years, then we will indeed experience the bang of the hammer and have missed our own industry’s ―fair warning”.

1) Unendowed reserves and working capital include funds invested for the short and intermediate term – investment vehicles like the Common Fund. Their earnings were typically driven by Treasury bill rates which were below 0.2% for most of 2009, and were below 0.1% for the last quarter of the year.
2) A comparison of the COTH data reflecting margins for the fourth quarter of 2008 to the second quarter of 2009 lends supports to PBOs comments. That is, the median margin went from –1.3% to +8.1% during this period.
3) According to data collected on the FY 2009LCME Part I-A Annual Financial Questionnaire, the average change in practice plan revenue was about 6%.
4) The medians obscure huge differences between schools – total revenues in FY08 ranged from more than $1.5 billion to less than $10 million. See http://www.aamc.org/data/finance/. 5 Almost 40% of the funds supporting medical school activities are not directly controlled by the leadership of medical schools. Most often, these revenues are related to expenses of affiliated hospitals or clinical practice operations that are “offthe-books” of the medical school. Furthermore, funds associated with sponsored grants and contracts, which represent nearly 30% of total medical school revenues, are “restricted” by sponsors to a specific purpose, as are most gifts.
6) It is important to recognize that endowments exist because donors elect to fund certain programs. In general, the funds are restricted to specific uses and cannot be set aside and used for one-time expenses. If, for example, a given endowment is established to fund new faculty positions or a research center, once established the school is generally obliged to support the activity even if the endowment earnings fall short. Consequently, it would be a mistake to characterize “relying on endowment earnings” as a “choice.” Comment by George Andersson, CFO, Washington University School of Medicine.
7) Stephen J. Heinig, M.A., Jack Y. Krakower, Ph.D., Howard B. Dickler, M.D., David Korn, M.D. Sustaining the Engine of U.S. Biomedical Discovery. NEJM, September 6, 2007, p. 1042-1047.

APPENDIX

INTERVIEW QUESTIONS

I. Nature of crisis:

1) Cause(s) of stress including reductions in

  •  state support
  •  endowment earnings 
  • gifts
  • clinical practice income
  • hospital support
  • other fund sources

2) $ Magnitude

3) Previous use of funds (e.g., recruit faculty, financial aid, support/underwrite research)

II. Steps taken to address crisis:

1) Staff actions (e.g., furloughs, lay-offs, hiring freezes)

2) Revenue/Expenditure actions (e.g., increase tuition, limit discretionary spending, reduce salaries, eliminate raises, delay capital projects)

3) Restructuring/programmatic actions (e.g., combine departments, change curriculum, reorganize administrative functions)

4) Decision process

5) Who was involved (e.g., dean, FPP director, chairs, hospital, parent university)

6) communication strategy

7) Complicating factors (e.g., unions, tenure, commitments, partners, contracts)

8) Timeframe — near and longer-term actions

III. Outcomes and Unanticipated Consequences

IV. Advice/Lessons for others

1) major challenges

2) roadblocks

3) miss-steps

4) facilitating conditions

5) crisis as an opportunity to drive change

1 See, for example, Sickinger T. Downturn Cripples OHSU Staff. Oregonlive.com. December 2, 2008. http://www.oregonlive.com/business/oregonian/index.ssf?/base/business/122819191672940.xml&c oll=7

Loyola University Health System Cutting More Than 440 Jobs. Chicagotribune.com. May 12, 2009. http://www.chicagotribune.com/topic/wgnam-loyola-090512,0,1204730.story

Gallagher K. Medical College of Wisconsin Will Cut It’s Budget by 5%. Milwaukee Journal Sentinel. March 21, 2009. http://www.jsonline.com/business/41608377.html

Jan T. Harvard to Lay Off 275. Boston.com June 23, 2009. http://www.boston.com/news/local/breaking_news/2009/06/harvard_u_to_la.html

The UW System Furlough Guidelines. University of Wisconsin System. http://www.uwsa.edu/furloughs/

Furlough Information. University of Wisconsin Department of Medicine. http://www2.medicine.wisc.edu/home/hr/furlough