10 crucial investments for nonprofit healthcare providers: Consultant

While the sector is struggling, one expert offers these tips for coming out on top.

Nonprofit hospitals are facing another challenging year as Standard & Poor’s predicts more credit downgrades than upgrades and pressures to convert to value-based systems continue to gnaw at bottom lines.

To shore up the business, many nonprofit health systems are eying mergers, acquisitions or joint ventures, according to Michael Ancell, national segment leader for healthcare investments and senior consultant for Mercer, a global consulting firm. During this time, institutions may need to realign their investment strategy, he said. Some organizations may just be getting to that task after a busy year.

[Also: S&P says nonprofits have weak outlook]

“I was hearing last year, the need to consolidate the retirement plans,” Ancell said.  “It’s like cleaning out the garage. I think there’s a lot of focus on that this year.”

As healthcare organizations plan for 2015, Mercer advocates the need for investment assets to enhance balance sheet strength, fund capital investment needs, support operating budgets and maintain debt covenants.

Ancell offers 10 investment steps for nonprofits, which include using an outside consultant.

1. Set a risk floor for the system.

Most not-for-profit health systems are subject to debt covenants that may restrict the amount of investment risk they can take. Debt covenants limit the risk during a time many hospitals having outstanding debt, Ancell said.

This is the time to quantify the risk floor, that balance between risk verses the benefit of return.

2. Consider whether an improved operating environment boosts risk tolerance.

In 2012, reimbursement cuts, the Affordable Care Act and the need to implement electronic medical records forced hospitals to make technological upgrades.

“That required some huge IT spending,” Ancell said.

These improved operations, along with stronger economic indicators, may have improved a hospital’s risk tolerance.

3. Assess the governance structure of investment portfolios.

Investment issues may have taken a back seat as finance staffs have been swamped and hospitals have been trying to stabilize, according to Ancell.

“CFOs and boards didn’t have a lot of time to deal with investment issues,” Ancell said.

Delegating certain functions of the investment function to focus on strategy may be the answer.

4. Consider the investment strategy in relation to strategic actions — needs may have changed.

Many nonprofit health systems have an eye towards M&A. Some of these actions may alter an organization’s balance sheet, with boards unwilling to tolerate a significant asset decline post-action, Ancell said.

“Their debt situation may have changed,” Ancell said. “There may be significant changes in financial metrics. They want to make sure they don’t end up with market decline after that.”

Finance and investment committees should consider how best to integrate investment with other strategies and whether these factors may necessitate a change in the investment risk profile.

5. Conduct a post-merger investment policy survey.

Combining organizations and their corresponding committees warrants revisiting key investment policy questions.

“If you bring two organizations together, two investment committees, two investment approaches, you have to take a methodical approach to combining that,” Ancell said.

Mercer suggests a survey to see if everyone is on the same page.

6. Develop a strategy for getting a defined benefit plan fully funded to ensure you’re ready to act.

There are quite a few systems with defined benefit pension plans that are a lot are less than 100 percent funded, Ancell said. Even if pension plans are currently frozen, organizations still have numerous employees who will be getting these pension benefits. Organizations need to put together a plan to get fully funded.

As funded status improves, a new road map to cut down on risk may include allocation adjustments based on plan design changes, fixed income composition changes and risk transfer methods.

7. Recognize the growing importance of your defined contribution plan.

With pension plans frozen, an organization needs to ensure that the organization’s current benefit plan is optimized to attract and retain talent, Ancell said.

These plans are complicated when there are mergers.

To deal with multiple plans, hospitals need to adopt a set of best practices that includes an assessment of investment structure, fees, target date line-up, incentives for participation, communication strategy and options for managing through retirement.

8. Clearly define DC plan governance and consider whether this is an HR function or finance/investment committee responsibility.

In the past, the defined benefit plan has been the function of human resources. Organizations may wish to rethink this as a responsibility of finance, as recent regulatory attention has focused on DC plan fees and is likely to expand to other areas, Ancell said.

9. Review the fixed income allocation and evaluate whether unconstrained bond funds could be a component of a fixed income program.

“We’ve had a lot of questions over the years, aren’t interest rates going up?” Ancell said. “We could be in a low rate environment for a long time.”

Healthcare operating portfolios are generally conservative, but revenue shortfalls may increase reliance on portfolio returns. Low fixed-income yields present a challenge. Organizations should determine if the size and composition of fixed-income holdings remain appropriate and consider unconstrained bond funds.

10. Set an illiquidity budget as part of managing the overall risk profile.

Some systems are increasing their allocations to private or illiquid assets. Yet rating agencies may count illiquid assets in days-cash-on-hand calculations. The investment committee should set an illiquidity budget as part of the overall risk profile.

“Go in with eyes open,” Ancell said.

Twitter: @SusanMorseHFN