I’ve been working in healthcare finance for about 26 years and I can’t think of another time when we had this level of risk within the industry. (Eric Jordahl, Kaufman, Hall & Associates)
A phrase commonly heard in many industries—risk management—migrated to the healthcare industry several years ago. But the financial crisis has moved risk management to the top of board agendas. Today’s boards are struggling with how to define and fulfill their governance roles in light of changing regulations. (Deloitte Insights, Governance and Risk Management Services, 2012.)
The iProtean course Managing Risk provides the necessary information for board members to discuss their organization’s risk portfolio. Michael Irwin (CitiGroup), Lisa Goldstein (Moody’s Investors Service), Marian Jennings (M. Jennings Consulting) and Eric Jordahl (Kaufman, Hall & Associates) discuss the multiple types or risk, debt and investment risk, the importance of using a balanced portfolio approach, and some of the key challenges for the board’s investment committee.
The first thing we always think about is the financial risk . . . establishing a clear set of financial targets about your balance sheet and your operating performance, through your finance committee. So you need to check that off your list. But even if you have done that well, you need to be cognizant of the other intrinsic business risks in your environment. The risk of a new business venture—either a new service or entering a new geography is risky. A risk that you’re doing too many things simultaneously is risky; a risk that the payers are going to fundamentally change the incentives for what you provide and things that are winners today might be losers in the future is risky. An assumption that what worked for us before will work for us in the future is risky.
So it’s important to go through each of these manifestations of risk, think them through, don’t let them paralyze you, actually view them as something that enables you to name them and start taking action to minimize each one.
The most important element is to think of risk across the organization, to understand debt related risks and how those risks show up, what they mean, what is the magnitude of those risks, but then to be able to compare how the realization of one of those debt related risks plays out across the organization if other risks are showing up.
So if the asset side of the equation is experiencing distress, if the operating side of the equation is experiencing distress, do you really want to be having this piece of debt also carrying risk? It’s thinking about risk-reward over the continuum of the entire organization, operations, liabilities, assets, where do you have risks, what kind of return are you generating off of those risks, are you realizing a big enough return relative to the potential impact of a realized risk in order to justify holding on to it or do you want to just eliminate it.
Boards have to be careful that they don’t become too conservative in their debt policies and let me give you an example of what I’m talking about here. Several years ago I remember attending a finance committee meeting of a small community hospital, and as I was talking about some of the financing options that were available to that organization, one of the trustees said, “Sonny, we don’t do that here. We’re very, very conservative. We only borrow in the fixed rate market and on the investment side all we do is invest short term and roll over treasury bills or treasury notes. That’s the way we like it, very conservative.” And I pointed out to them that in fact inherent in those two decisions, by not looking at how the balance sheet works—the left hand side and the right hand side of the balance sheet have to be working together—that two conservative policies actually lead to a speculative position on interest rate.
In the example I just gave, that organization would do just fine in a higher interest rate environment when they would get a higher investment return on their short term investments while their interest rates were fixed. However, over the last 10 or 15 years, and this is away from the financial crisis, that would have been a poor decision because they would have fixed the interest rate on their debt, leaving them with a fixed level of interest expense, but their investments would have been reduced year over year over year during a period of high liquidity in the markets and low returns on treasuries and other short term investment instruments.
So a better alternative and one we see evolving now is for organizations to have a mix of both fixed and variable rate debt on the right hand side of their balance sheet which better reflects what they’re doing on the investment side of their balance sheet where they’ve got some exposure to equities, some exposure to alternative investments that match up on a long term investment horizon, and yet the short term investments provide a natural hedge for the variable rate exposure they would have in the variable rate component of their debt. So in a market that would see increasing interest rates, their interest expense would go up a little, but their non-operating income would also go up to offset that. It’s that kind of hedging position that I think organizations should try to achieve.
From our perspective, whether it be a debt portfolio assessment or a portfolio assessment on investment strategies, we want to get an understanding that the hospital and the board are fully aware of the rewards and the risks involved in whatever balance sheet strategies they take.
So our recommendation to trustees would be as an organization to sit down and look at your investment policy. An investment policy isn’t something that should be done once and then forgotten. An investment policy is something that has to be constantly evaluated in light of the market and the resources of the organization.
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iProtean Symposium & Workshop
Mark the Date!! October 10 – 12, 2012 at The Lodge at Torrey Pines, La Jolla, CA. Faculty: Barry Bader, Dan Grauman, Marian Jennings and Brian Wong, M.D. For more information, click here.
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