Looking to strengthen your organization’s future? Reconsider investment priorities.
Healthcare systems are facing significant financial pressure. Americans are getting older, increasing the demand for healthcare, while reimbursements aren’t going up in kind. Uncertainty regarding national healthcare policy, as well as the constant challenge of recruiting and retaining high-quality nurses and doctors, are adding to these formidable challenges. In this era of squeezed margins, a thoughtful investment strategy can help healthcare systems position themselves for a strong future.
Pavilion recommends that not-for-profit healthcare organizations prioritize the following actions in 2019.
- Consider the “healthcare foundation.”
According to Moody’s, 2017 showed the largest decline in health system operating cash flow margins of any year over the past decade. This is driven by slower revenue growth due to declining reimbursement rates, shift to outpatient care and the growth of government payers.
Dealing with continued operating pressure is likely to be one of the key issues health systems face in the years ahead. Based on the industry outlook, many healthcare entities will continue to rely on their investment portfolio to meet budgeted returns. In an expected lower-return environment from traditional liquid investments, it begs the questions: Should health systems consider a longer-term, less-liquid approach to managing their portfolio to increase return expectations? Should health systems adopt an asset allocation that is similar to that of a foundation?
While each health system faces unique circumstances, it is prudent to re-assess liquidity needs and position the portfolio to optimize investment return potential.
- Conduct comprehensive enterprise planning and risk management.
One consideration holding systems back from adopting more aggressive portfolio allocations may be increased capital spending plans. It is imperative that systems integrate their investment strategy with their long-term financial plan to gain a holistic financial picture of their organization.
Just as systems should take a comprehensive look at their financial plans, so should they take a comprehensive view of enterprise-wide risks. Health systems have many investment pools and debt obligations, which should be assessed together. Taking a holistic approach allows organizations to make informed decisions that better support the mission and vision of the system.
- Recognize that governance may need to evolve.
Many systems have multiple committees overseeing their various investment pools. As organizations move toward an enterprise-wide approach, committee oversight may need to adjust and may vary depending on organizational needs, the number of investment pools and the desired level of interconnectivity in the enterprise. But ideally, an oversight committee would see a roll-up of the total risk picture and how its mandate impacts the system as a whole.
- Leverage the blessing of rising interest rates.
Since most systems are asset sensitive, rising interest rates will help most systems’ bottom line in 2019. For many systems, fixed rate debt dominates their liability mix. The two-year Treasury yield has risen sharply over the past year. As interest rates rise, most health system debt service costs won’t increase much, but yields on fixed income and cash may rise significantly. This should help system profitability in 2019. But this will only partially mask the long-term cost of carrying excess liquidity. That said, systems should assess how much interest rate risk they carry. As we near the end of an interest rate tightening cycle, systems may wish to reposition so that the next rate-cutting cycle will not hurt profitability.
- Consider how you are integrating responsible investing.
The topics of ESG, impact, community investing and strategic healthcare innovation investing continue to garner attention. Considerable thought is required to determine how best to integrate these programs into the investment portfolio. Governance, use of internal and external resources, due diligence and the balance of impact versus monetary return expectations are key topics for discussion.
- Pay attention to retirement plans.
Recent lawsuits against higher educational institutions regarding governance of 403(b) plans have sent a warning to all plan sponsors that they have a fiduciary duty to obtain competitive services for their plans. Bipartisan legislation proposed in 2018 and expected to be reintroduced next year (the Retirement Security and Savings Act) would permit commingled investment trusts in a 403(b) plan structure. If enacted, this reform could significantly lower plan costs; as such, fiduciaries should monitor legislative developments.
- Have a plan for corralling pension risk.
Untimed contributions and rising costs of overall pension plan management pose significant financial risks for some healthcare organizations. Does your organization have a comprehensive strategy for its pension plan(s) to achieve desired financial outcomes? Recent increases in interest rates coupled with strong equity markets have improved funded status. Many organizations have elected to eliminate pension risk from their balance sheets by terminating their plans. Available steps for managing pension risks include lump-sum buyouts and a limited annuity purchase.
This paper was authored by a team of Mercer and Pavilion thought leaders in the not-for-profit healthcare investing sector.