Executives at not-for-profit health-care organizations are finding management of their systems' investible assets is becoming more critical as increasing regulation threatens to decrease revenue.
Assets once relegated to the sidelines as health-care systems pursued their core missions are now taking a prominent place on the balance sheet. Plus, as the industry evolves from single hospitals to increasingly large networks with large investment pools to match, investment consultants and money managers are paying more attention, too.
The investment portfolio is “probably now getting the appropriate amount of attention, given its sheer size,” said James Bosscher, senior vice president and chief investment officer for Trinity Health in Novi, Mich., who oversees an investment portfolio of $8.5 billion.
“Health-care delivery in America is going through a corporatization, and as the organizations have grown and consolidated, the balance sheet and the portfolio have grown rapidly” said Paul Clark, vice president of research and education for the Health Management Academy, Alexandria, Va. “These health systems have only now begun to understand the importance of the investment portfolio to the organization.”
Illustrating the increasing importance of investments is a survey of 90 not-for-profits by The Commonfund Institute, which found that median investment income as a percentage of net income jumped to 50% in fiscal 2010 (the most recent data available) from 15.8% in fiscal 2008.
As financial markets improved but reimbursement rates got squeezed, even those systems with $1 billion or more in investible assets had investment income account for 36% of net income, the survey showed.
“That full balance sheet is more and more important to our health-care clients,” said Frank Domeisen, area president for Pittsburgh-based consultant Gallagher Fiduciary Advisors LLC, formerly Yanni Partners. “Our work has shifted to paying more attention to that.”
Single-digit operating margins are the norm for even large health-care systems. For some systems, “their investment portfolio returns put them back in the black in difficult times,” said Gregory S. Grabar, senior vice president and head of the health-care practice at Pacific Investment Management Co., Newport Beach, Calif. PIMCO has $37 billion in assets under management for health-care organizations.
Leading the pack in terms of how health-care institutions view their growing investment programs is Ascension Health Alliance, the St. Louis-based network with $20 billion in 10 investment pools. Ascension, the second-largest not-for-profit health-care organization in terms of investible assets, started its own subsidiary, Catholic Healthcare Investment Management Co., last year.
“We've taken the treasury department and created a separate company,” Chief Investment Officer David E. Erickson said in an interview. His staff of 20 includes nine full-time investment professionals handling asset pools such as a large operating fund, defined benefit and defined contribution plans and a self-insurance fund, among others.
Once the firm receives its SEC registration — which could happen as early as this month — officials will be able to take on other clients, Mr. Erickson said.
While few health-care organizations would ever approach that level of portfolio management, they do share a few key concerns, beginning with the number of investment pools they have to juggle.
A 2010 survey by investment consultant NEPC LLC, Cambridge, Mass., of nearly 50 not-for-profit health-care institutions representing more than $75 billion in assets found that 85% had three or more investment pools, most commonly operating assets and defined benefit plans. Roughly two-thirds also had foundations and self-insurance pools, often with disparate investment goals.
NEPC has 35 health-care system and stand-alone hospital clients, with a total of $34 billion in assets.
“There is a lot of customization that takes place. They are some of the most complex investment programs, with almost every type of asset pool. You need depth and breadth,” said NEPC Partner K.C. Connors in Minneapolis. Paul Kenney, partner in Detroit, agrees: “It keeps you sharp.”
Meanwhile, health-care organizations' single-digit operating margins conflict with the constant demands on capital for updating facilities and equipment, and meeting government mandates, or to even consider expansion plans. Unable to issue equity, they rely largely on issuing debt, which means satisfying the ratings agencies to make that debt as affordable as possible.
This need to please traditionally has affected the asset allocations of the systems. The 90 institutions surveyed by Commonfund, for example, had an average fixed-income allocation of 37% in fiscal 2010. Exposure of other not-for-profits was lower — 20% for operating charities and 13% for foundations, according to Commonfund.
But executives at not-for-profit health-care organizations would like to get some recognition from the ratings agencies that further reducing the fixed-income exposure is not going to hurt liquidity, and could even help boost returns.
Beth Wexler, senior credit officer in Moody's Investors Service public finance group in New York, said the view of liquidity by Moody's officials “has evolved over the last several years. We've taken a deeper look at how their investment strategies work. We don't tell them how to invest, but we do look at what that strategy brings to the table and whether it appears to be working for them.”
Said Mr. Grabar of PIMCO: “A ratings upgrade is very beneficial to a health system. That impacts the receptivity and cost of their debt. The ratings agencies are constantly monitoring their financial conditions so they need to maintain certain levels of liquidity. “
From there, the investment options depend on how much liquidity clients have built up or might need to draw down for capital projects.
“It all depends on how much cash you have on the balance sheet,” said Pamela Schmidt, vice president of treasury services for Bon Secours, a not-for-profit health-care organization based in Baltimore. “That really drives what you can do with your investments.”
Another pressure point is pension plans. According to a Moody's survey of 225 hospital systems with defined benefit plans, the medium funding ratio dropped to roughly 70% in 2010 from more than 80% in 2008, thanks to low discount rates. Also, not-for-profit health-care systems are following the corporate trend toward freezing defined benefit plans and switching to defined contribution plans.
Consultants and money managers say the executives in charge of health-care organizations' investible assets increasingly are willing to consider new approaches.
Joseph Gelly, managing director of fiduciary solutions at Seattle-based Russell Investments, has seen “a great deal of activity” in his area in the past 18 months from health-care clients, who represent about 12% of Russell's U.S. institutional asset management business.
“They are recognizing that the way it was done 15 years ago has changed dramatically,” added Lisa Schneider, managing director of client service at Russell in New York.
“It comes from the need to really focus on the risk side, not just the return side,” Ms. Schneider said.
“I think you see more use of liability-responsive asset allocation. I do see them recognizing the value of this kind of dynamic asset allocation, which is equally valuable for smaller institutions. This is a lot more complex game than the old buy-and-hold mentality,” Mr. Gelly said.
Michael T. Lytle is a consultant with Highland Associates Inc. in Birmingham, Ala., an investment consulting firm whose clients primarily are not-for-profit health-care organizations and whose founders include a former hospital CFO.
“There are returns to be had if you have a philosophy that's not set-it-and-forget-it,” Mr. Lytle said. “How their portfolio fits in with everything else is a big education. Once they get it, they are OK with having a different asset allocation” from what they traditionally had.
NEPC's Ms. Connors said that when health-care systems started feeling the pressure to push return and adopt the endowment portfolio approach about a decade ago, “the challenge was that everyone went in thinking they were more risk tolerant than they were.”
That makes risk tolerance and assessment an important first step. At Ascension, one of the first hires was a director of risk management.
At consultant Mercer LLC, “we try to quantify in advance what kind of downside we'd expect in certain scenarios and ask, "can you live through that?' so you're not having these discussions when everybody's frantic,” said Michael Ancell, a principal in Clayton, Mo., who chairs the health-care strategic research team. “You have to be broadly diversified. Advisers have to make sure that clients understand that this is a lower-return environment.”
The degree of input from outside firms varies widely among the institutions. Mark Amiri, vice president and treasurer for Baylor Health Care System in Dallas, has his $1.8 billion investment portfolio handled by external managers, except for some private equity and hedge funds that he handles. “We rely on Summit (Strategies Group, Baylor's investment consultant) a lot to be somewhat tactical, and they did a lot of research,” he said.
By contrast, the desire to embrace esoteric strategies led the Cleveland Clinic Foundation to outsource investment management of its $5 billion in investment pools to Strategic Investment Group, Arlington, Va.
“We liked the idea of more hands-on portfolio management instead of portfolio advice. It allows us to be more dynamic in a more flexible way, and it helps to have someone versed in all kinds of strategies,” George K. Mateyo II, senior director of investments at Cleveland Clinic, said in an interview. “We think of them as a co-fiduciary, which we think is a significant plus.”