Although revenue has grown significantly over the past few decades, with it comes increased regulatory scrutiny and the need for the business model to evolve, creating additional pressure on margins.
As entities become more complex, there is a need to more closely review the structure of various organizational asset pools and their potential role in accomplishing strategic objectives. When it comes to management of healthcare provider investment portfolios, industry leaders must not lose sight of their enterprises’ overall mission and the role investment volatility may play in total financial health.
A Holistic View Brings Unique Insights
Healthcare systems can benefit from taking a holistic approach to management of their investment assets. Many nonprofit providers today are placing greater focus on the strategic role of unrestricted assets and how the risk inherent in the management of these asset pools contributes to overall risk to the organization. Furthermore, healthcare systems generally have more than one investment pool with distinct objectives, including retirement plans, operating reserves, foundations, and self-insurance pools. With a holistic approach to investment management, which our team refers to as enterprise investment risk management (EIRM), the investment strategy for each pool is viewed in the context of the organization’s broader financial strategy.
Goals & Objectives
The first step in a holistic approach is defining the investment objective of each portfolio and understanding the relationship of each portfolio to the organization’s financial health and mission. This initial step lays the foundation for an EIRM analysis since it helps to determine each pool’s return needs and risk tolerance, with consideration of the system’s unique financial position and requirements.
Business & Projections
The second step is gathering and analyzing the organization’s financial projections, such as revenues, expenses, capital structure, and covenant calculations. Marrying business projections with return and volatility expectations for varying asset allocations is crucial, setting the stage for garnering insight into the relationship between investment assets and key financial metrics.
Enterprise Investment Risk
The third step, the enterprise analysis, provides insight into how market volatility or changes in the investment strategy may affect vital financial metrics, such as days cash on hand, leverage, and debt service coverage.
Holistic Investment Strategy
Ultimately, the result is a customized asset allocation strategy for all investment pools, the final step. The optimal asset allocation most efficiently balances return needs with the appropriate risk budget. This comprehensive approach highlights the probabilities of achieving targeted organizational results by tying investment decision-making to the entity’s most important financial objectives.
More Empowered Decision-Making
A greater understanding of the organization’s ability to tolerate investment risk is the result of the EIRM framework. This in turn equips key individuals with answers to questions such as:
- How does increasing/decreasing risk of the operating reserve pools increase/decrease the volatility of debt covenant ratios?
- How does incorporating private alternative investments affect organizational liquidity?
- What is the correlation between the operating reserve pools and the employer-directed retirement plans? How would a decline in interest rates affect the two simultaneously?
- How does a decision to finance a capital project affect overall financial risk tolerance?
We have seen the EIRM approach lead a Midwest health system to adopt a more appropriate asset allocation in its long-term operating pool. In this case, the entity was in strong financial health, with consistent operating gains and an enviable payer mix. However, the asset allocation targets for the operating assets were overly conservative, in our view, and the finance committee wanted to assess whether to increase risk (and return opportunity) in their portfolio.
An EIRM analysis revealed that, thanks to the significant financial strength of the organization and solid operating position, there was an opportunity to increase equity exposure. While a 100% equity portfolio would have provided few scenarios that jeopardized debt covenant compliance and overall financial wellbeing, the investment committee agreed to increase the equity stake by 15%. In subsequent years, the organization had higher returns from an increased equity allocation, further strengthening its financial position.
Balancing Financial Risk Can Yield a Sharper Focus
A holistic approach to managing asset pools can help healthcare leaders optimize investment programs, bolster financial standing, and provide key mission support. By assessing the relationship between investment risk and overall financial risk and position, a healthcare organization can adopt a collectively balanced risk posture, creating more capacity to focus on the many other matters pressing providers today.
To learn more about how we can bring ideas, insight and solutions to you, please contact your Relationship Manager or fill out a simple Contact Form and we’ll get in touch with you.