Return on Equity

Return on Equity in Health Care Finance

Return on equity (ROE) tells an owner how much accounting profit a health care organisation earned in a year for each pound of capital the owner has put in or left in the business. Investors and lenders use it to judge hospital groups, insurers and drug companies, and an analogue applies to public and not-for-profit providers, whose residual claim is held by taxpayers or communities. The ratio matters in health systems because the return allowed to, or demanded by, the holders of equity shapes how providers are paid and how much capital flows into hospitals, insurance and drug development. It splits exactly into a profit margin, an asset turnover ratio and a measure of borrowing, so two organisations with the same ROE can be earning it in very different ways.

Who holds the equity in a health system

Equity holders carry the residual risk. Turner and colleagues, writing on US hospitals, describe the equity holders of investor-owned hospitals as those with a residual claim on hospital assets after debt obligations are met. Not-for-profit and government hospitals are supported instead by local communities, states and the federal government, through tax revenue forgone or directly through general taxation. The same authors argue that hospitals of every ownership type need positive returns on equity to replace capital and finance growth, and that inadequate ROE makes borrowing hard.

In the English NHS the owner is the state. The Department of Health and Social Care (DHSC) guidance on financing for NHS trusts and foundation trusts describes public dividend capital (PDC) as the DHSC investment in each provider, with no defined repayment schedule, shown in the taxpayers' equity section of the provider's statement of financial position. The Secretary of State requires providers to pay a PDC dividend of 3.5% on actual average relevant net assets during the financial year, and the guidance states that, following a review, the rate will remain fixed at 3.5%. The dividend works as a fixed charge for the use of public equity, set by the owner, against which a trust's surplus can be read.

Calculating ROE and the choices behind the number

Because equity changes during the year, the opening and closing balances are often averaged. Bai and colleagues, in a study of publicly traded US health care companies, define ROE as net income divided by the average of beginning and ending book value of equity.

$$ROE = \frac{NI}{\bar{E}}, \qquad \bar{E} = \frac{E_{0} + E_{1}}{2}$$

where $NI$ is net income for the period after all expenses, interest and tax, $E_{0}$ and $E_{1}$ are book equity at the start and end of the period, and $\bar{E}$ is average equity. For a not-for-profit hospital the equity line is usually called net assets or fund balance, and for an NHS trust it is taxpayers' equity.

Several choices move the result. Where assets are carried at historical cost less depreciation, an old, heavily depreciated hospital estate gives a small book equity and a flattering ratio. The ratio has no useful meaning when equity is zero or negative. Bai and colleagues required every denominator to be greater than zero, and the Healthcare Financial Management Association (HFMA) found that 30 NHS provider bodies had negative net assets at the end of March 2019 and paid no PDC dividend that year.

The DuPont split into margin, turnover and gearing

The DuPont identity rewrites ROE as the product of three ratios, each answering a separate management question. Turner and colleagues date it to the DuPont Corporation in 1914 and describe the three parts as profitability, efficiency and capital structure.

$$\frac{NI}{E} = \frac{NI}{R} \times \frac{R}{A} \times \frac{A}{E}$$

where $R$ is total revenue, $A$ is total assets and $E$ is equity. The first term is the profit margin, the share of each pound of revenue left after all costs. The second is total asset turnover, the revenue generated per pound of assets. The third is the equity multiplier, which rises as more of the asset base is financed with debt. The first two terms multiplied together give return on assets, so ROE equals return on assets times the equity multiplier, and the gap between the two ratios is entirely a matter of financing.

The gearing term cuts both ways. Turner and colleagues explain that when a hospital earns a return on assets above the return demanded by its lenders, the excess goes to equity holders, so more debt raises ROE even though margin and efficiency are unchanged. When income falls short of what lenders are owed, equity holders make up the difference.

Bai and colleagues give an example from 2019 annual reports. Pfizer reported an ROE of 0.26 from a margin of 0.31, asset turnover of 0.32 and financial gearing (assets over equity) of 2.58, and UnitedHealth Group an ROE of 0.25 from a margin of 0.06, turnover of 1.49 and gearing of 2.98. The drug company earned its return through high margins on a large asset base and the insurer through thin margins on high volume.

What hospital and industry studies show

Turner and colleagues applied the DuPont split to 3,255 US short-term acute care hospitals, using Medicare cost reports (CMS Form 2552). Between 2007 and 2011 the hospitals averaged an ROE of 9%, a margin of 0.05, asset turnover of 1.22 and an equity multiplier of 1.95. Investor-owned hospitals had a mean ROE of 25%, against 8% for not-for-profit and 3% for government hospitals. In their means table the investor-owned group had the highest margin (0.11) and turnover (1.74) but a lower equity multiplier (1.75) than not-for-profit hospitals (2.02), so its advantage came from margin and turnover rather than from debt.

The sample averages carry a lesson about method. The product of the mean components, 0.05 times 1.22 times 1.95, is about 0.12, not the mean ROE of 0.09. The identity holds hospital by hospital, but the mean of a product is not the product of the means when the components vary and are correlated, so decomposition should be done for each organisation before results are averaged.

Bai and colleagues compared 1,231 publicly traded US health care companies in ten industries between 2010 and 2019. Pharmaceutical and biotechnology companies had lower ROE, driven by low margins and low asset use, and higher ROE volatility than the other industries, while health care facilities relied most on debt financing. The authors note that profit margins have been compared across industries to inform policy on drug pricing and insurance regulation, and argue that margin alone ignores differences in asset use and risk. They caution that their results may not apply to nonprofit organisations, which play a large part in the US hospital sector.

Regulated returns on equity in provider payment

Payers have at times written a return on equity directly into provider payment. Under Medicare cost-based reimbursement, the regulation at 42 CFR 413.157 provides that a reasonable return on equity capital invested and used in patient care is paid to proprietary providers as an allowance on top of the reasonable cost of covered services. The base rule set the allowance at the provider's equity capital multiplied by one and a half times the average interest rate on special public debt issues bought by the Medicare Part A Trust Fund, but lower percentages applied to inpatient hospital services from 20 April 1983 and to other services from 1 October 1985. Equity capital was plant and equipment net of depreciation and related non-current debt, plus net working capital, averaged over the period.

For inpatient hospital services the allowance fell in steps and reached zero for cost reporting periods beginning on or after 1 October 1989. It ended for outpatient hospital services furnished from 1 January 1988 and for skilled nursing facility services from 1 October 1993. In a June 2011 transmittal the Centers for Medicare & Medicaid Services (CMS) deleted the manual chapter on the allowance because Medicare no longer pays it. Because the allowance grew with the equity base, it tied part of each provider's payment to capital invested rather than to services delivered, a different basis from most forms of provider payment.

The NHS PDC dividend runs the other way, with the provider paying a fixed return to its owner. The HFMA points out that the dividend is 3.5% of average relevant net assets, not 3.5% of PDC. The DHSC guidance deducts average daily cleared cash balances held with the Government Banking Service, and adds revenue support PDC to net assets as soon as it is drawn, to recoup the opportunity cost of the cash.

Worked example of gearing in a hospital group (illustrative)

All figures in this example are illustrative. An investor-owned hospital group has revenue of GBP 400 million, net income of GBP 20 million, average total assets of GBP 320 million and average equity of GBP 128 million.

1. Direct ratio. ROE is 20 / 128 = 0.15625, or 15.6%.

2. DuPont components. The margin is 20 / 400 = 0.05, asset turnover is 400 / 320 = 1.25 and the equity multiplier is 320 / 128 = 2.5. Their product is 0.05 × 1.25 × 2.5 = 0.15625, matching step 1. Return on assets is 20 / 320 = 0.0625, and 0.0625 × 2.5 = 0.15625.

3. More debt, same hospitals. The group borrows GBP 64 million at 5% interest and returns it to shareholders, so assets are unchanged and equity falls to 128 − 64 = 64 million. Tax is ignored for simplicity. Interest is 64 × 0.05 = 3.2 million, net income falls to 20 − 3.2 = 16.8 million and ROE rises to 16.8 / 64 = 0.2625, or 26.25%. Return on assets falls to 16.8 / 320 = 0.0525, or 5.25%.

4. A bad year. Suppose net income before the new interest falls to GBP 4 million. Without the extra debt ROE is 4 / 128 = 0.03125, or 3.1%. With it, net income is 4 − 3.2 = 0.8 million and ROE is 0.8 / 64 = 0.0125, or 1.25%.

5. Break-even. The extra debt raises ROE only when (NI − 3.2) / 64 exceeds NI / 128, which holds when NI exceeds 6.4 million. At that point ROE without the extra debt is 6.4 / 128 = 0.05, equal to the interest rate, so the extra borrowing helps the owners only while the return on equity it replaces beats the cost of the debt.

6. A public comparator. An NHS trust with average relevant net assets of GBP 250 million pays a PDC dividend of 250 × 0.035 = 8.75 million, so a surplus of GBP 10 million before the dividend, a 10 / 250 = 0.04 return on relevant net assets, leaves 1.25 million.

The hospitals are unchanged between steps 2 and 3, yet ROE moves by more than ten percentage points. Any comparison of ROE between hospitals, or over time, needs the equity multiplier alongside it.

Reading ROE in health economics and policy

ROE measures the financial return to one group of claimants and says nothing directly about health gain or value for money. A hospital with a high ROE may deliver poor value to its payers, and an economic evaluation from a payer perspective treats the provider's profit as part of the price paid. Payers that set prices need to know whether the return they allow attracts enough capital to sustain services. In health insurance markets the DuPont split shows whether a cap on the share of premiums kept for administration and profit, such as a medical loss ratio rule, has squeezed margins or been offset by turnover and gearing.

Boundaries with nearby ratios

Return on assets measures profit against all capital whoever supplied it, and is the better guide to operating performance when organisations are financed differently. Return on investment is usually computed for a single project or programme, and in health care it often counts savings or health gains rather than accounting profit. A liquidity ratio measures the ability to meet short-term obligations, and a hospital with a strong ROE can still run short of cash. For a decision on a new unit, net present value at an appropriate discount rate is the right tool, since ROE looks back over a single accounting year.

Limitations and common misreadings

Most errors with ROE come from treating it as a pure measure of performance. The ratio mixes operating results with financing and accounting choices, and each can move it on its own.

1. Reading gearing as efficiency. Debt raises ROE in good years and deepens losses in bad ones without any change in how patients are treated.
2. Ignoring the size and sign of the denominator. Depreciated assets, write-downs or accumulated deficits make book equity small or negative and the ratio meaningless.
3. Averaging ratios and then decomposing. The DuPont identity holds for each organisation, not for sample means.
4. Comparing ownership types without adjustment. Not-for-profit and public providers do not seek to maximise returns to owners, and their equity reflects donations, grants and public capital.
5. Treating ROE as a welfare measure. From a societal perspective profit is a transfer between payers and owners, and a high return may reflect market power rather than efficiency.

Sources

• Bai G, Rajgopal S, Srivastava A, Zhao R. Profitability and risk-return comparison across health care industries, evidence from publicly traded companies 2010-2019. PLOS ONE. 2022;17(11):e0275245. https://doi.org/10.1371/journal.pone.0275245
• Centers for Medicare & Medicaid Services. Medicare Provider Reimbursement Manual Part 1, Chapter 12, Return on Equity Capital of Proprietary Providers. Transmittal 445, June 2011. https://www.cms.gov/regulations-and-guidance/guidance/transmittals/downloads/r445pr1.pdf
• Code of Federal Regulations. 42 CFR 413.157, Return on equity capital of proprietary providers. Electronic Code of Federal Regulations, accessed 28 October 2026. https://www.ecfr.gov/current/title-42/section-413.157
• Department of Health and Social Care. Secretary of State's guidance under section 42A of the National Health Service Act 2006 (part of Finance available to NHS trusts and foundation trusts). Published 21 October 2014, last updated 10 February 2025. https://www.gov.uk/government/publications/guidance-on-financing-available-to-nhs-trusts-and-foundation-trusts/secretary-of-states-guidance-under-section-42a-of-the-national-health-service-act-2006
• Healthcare Financial Management Association. Understanding the implications of a debt for equity swap for NHS providers. 2 March 2020. https://www.hfma.org.uk/articles/understanding-implications-debt-equity-swap-nhs-providers
• Turner J, Broom K, Elliott M, Lee JF. A decomposition of hospital profitability, an application of DuPont analysis to the US market. Health Services Research and Managerial Epidemiology. 2015;2:2333392815590397. https://doi.org/10.1177/2333392815590397