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Nonprofit Hospitals Urged to Diversify Endowments

 |  By John Commins  
   February 26, 2013

Nonprofit hospitals should diversify their investment portfolios and reduce heavy bond and cash allocations while exploring alternative investments such as equities, a Commonfund Institute report recommends.    

William F. Jarvis, managing director of the Commonfund Institute, the nonprofit research arm of Commonfund, investment advisors to nonprofit institutions, says nonprofit hospitals need to adopt the Endowment Model of investment management used by many universities that relies upon "a highly diversified portfolio of assets with a higher than usual tolerance for illiquid assets."

Jarvis, the author of the study, (PDF)  notes that during the 2008-09 economic collapse,  healthcare organizations' portfolios suffered losses that were nearly as severe as other nonprofits, but did not recover as quickly.

He says heavy allocations to fixed income investments and cash, which totaled nearly 40% of the average nonprofit healthcare organization's portfolio, were due largely to rating agency requirements that tie favorable bond ratings to portfolio liquidity.

Because of that pressure, Jarvis says that many nonprofit hospitals remain concerned that any reallocation of assets will hurt their credit ratings.  "Historically the nonprofit healthcare organizations have taken their investable assets and put them into pools that are not as diversified as other types of nonprofits," he said.

"When we've asked them why is it that you have, for example, less in the way of equities, less in the way of alternatives investment, and so much more in the way of bonds, and fixed income and cash, they say 'it's because the rating agencies who rate the bonds we issue look to our investable assets as a potential repayment pool for the bonds to secure the rating on the bonds. Since we have to keep issuing these bonds to keep refreshing our physical plant we are sort of trapped.'"

Jarvis argues that healthcare organizations are better off with more highly diversified and liquid portfolios to support bond repayment. As organizations move toward implementation of more diversified portfolios, he says, rating agencies will need to be more flexible in their liquidity requirements.

"First thing, it's not completely a result of the Affordable Care Act, but it's certainly given impetuous by that, is the declining reimbursements for services provided, particularly from government but also from private payers going forward. The revenue model is changing so that the undiversified endowment is going to be insufficient to replace the reduced reimbursements," Jarvis explained.

"The second thing is the change that is being forecast in delivery methods. Part of this bond issuance structure is related to the traditional model of the big brick-and-mortal central hospital complex in the middle of the city with a physical plant that has to be refreshed and high technology input."

That traditional physical plant model appears to be changing.

"What I am hearing is that the care delivery for many of these institutions is changing to be much more light on the ground, much more clinic-based, with mobile clinics in shopping areas and in suburbs closer to the patients, even for fairly high impact procedures," Jarvis noted.

"So the cost and the financing of these is a different question than it was 10 or 15 years ago when you had a big central complex and you had to build a new wing or you had to gut the old wing and put new stuff in it every 10 years."

Jarvis says board members at one hospital talked about setting up clinics and operating rooms in big box retail buildings, "all on a very light and mobile basis, with walls that could be moved around as the need arose, and much less expensive."

He says it's time to "call out the rating agencies" for their failure to recognize and adapt to the changing landscape in healthcare.

"The interests of bond holders are poorly served by the existing endowment structural model that exists now," he says. "Over the long term, if you are issuing a 20-, 40-, 50-year bond you want a well diversified portfolio because only a well diversified portfolio is best positioned to provide the best risk-adjusted return that is going to be part of the financial health of the institution that will be repaying the bonds."

Jarvis says interest rates are at Zero now, and can't go any lower.

"Therefore bond portfolios are going to go down in value when interest rates start to rise. Rating agencies must know this. They are not stupid people," he says. "I would posit that having less dependence on this yield curve risk would be rather prudent risk management but we don't see a change coming in the description of what the optimal model should be. That is partly why I wrote the paper, to put together things that are not terribly novel but are lying around in plain sight."

John Commins is a content specialist and online news editor for HealthLeaders, a Simplify Compliance brand.

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