The financial challenges will reverberate throughout 2021. Leaders must navigate the road to recovery amidst a difficult and uncertain environment. Investment management, both internal and external, is a key pathway forward. This paper describes the current investment landscape and offers several strategies designed to help manage risk, preserve cash and potentially optimize returns.
Current Situation Analysis
The magnitude of the decline in provider revenue and profitability from deferral of inpatient procedures and the expense of COVID-19 treatment has made the task of returning to pre-pandemic levels a tall order. Total 2020 hospital losses were estimated at over $300 billion.1 Despite government support, operating margins were down 1.2 percentage points.2 Pricing power increased, but lower utilization levels prevented hospitals from realizing the upside.3
The pain is industry-wide. An August survey found that 72% of physician practices experienced income reduction, 41% saw volume decrease more than 26% and 8% closed.4 Two-thirds of nursing homes predicted potential closure within one year.5
Leaders enter the year facing several headwinds:
- Uphill healthcare recovery. Lost revenue remains the greatest overhang for 2021, according to one study.6 In another, 84% of health system CFOs said they expect 2021 operating margins to be well below plan.7 In yet a third survey, healthcare leaders predicted a median time of 12 months to recover financially.8 Moody’s industry outlook is negative.9
- New surge. A fresh surge of coronavirus cases over the winter months caused hospitals to redirect beds from elective procedures to COVID-19 treatment as well as increase spending on safety supplies and part-time clinicians.
- Uncertain macroeconomic environment. Only half of the 22 million jobs lost during the crisis have been restored, and the unemployment rate persists above 6%. Jobless claims remain elevated. One result is heightened health affordability concerns. Recent analysis placed the percentage of uninsured adults at 12.5%, with another 21% underinsured.10 Forecasts for 2021 of 4%+ GDP growth and 5-6% unemployment are promising, but carry high dependency on widespread vaccination stimulating robust economic activity.
The Investment High Wire Act
Investment decisions face the challenge of balancing three important objectives:
- Managing cash tightly. Sufficient liquidity is essential to meet fluctuating expenses and cushion against future shocks. Many providers need to plan for repayment of Accelerated and Advance Medicare reimbursements obtained during the crisis or restart of deferred payroll tax contributions. Cash is tight. According to one analysis, 46% of organizations have 31-60 days cash on hand, and only 27% have greater than 60 days.11
- Fueling revenue growth. Optimizing cash flow must coexist with funding efforts to grow revenue rapidly. One key is investment in telehealth to prevent revenue “leakage” and open new income streams. McKinsey projects a 113% compound annual telehealth growth rate through 2022.12
- Seeking higher investment returns. CFOs have little room to maneuver in the face of persistent low interest rates and a fairly flat yield curve. Most providers are barely earning anything on cash.
Solutions: An Enterprise View
A comprehensive assessment of options is optimal. A foundational approach is to conduct an enterprise investment analysis. This analysis rigorously examines organizational risk tolerance and seeks alignment with investment risk. The enterprise analysis looks holistically across the balance sheet to include retirement, liability reserve and all other short- and long-term investable assets. It likewise examines all financial relationships with payers, patients and suppliers.
A valuable step in operationalizing the analysis is to revisit the organization’s investment policy statement. Is it still the best guide for the institution’s investment activity? An enterprise perspective can also reveal steps that can augment investment returns. Four to consider:
- Internal investment management. Many healthcare finance teams work effectively with a partner to execute an investment program featuring self-directed, low-risk fixed income products and services that help leverage excess operating capital without losing access to liquidity. This approach enables healthcare providers to pick up spread over cash.
- Outsourced investment management. Healthcare finance teams sometimes carry very full loads and are stretched thin, in which case consistent attention to investment analysis and execution can be difficult. A trend that is gaining momentum is an Outsourced Chief Investment Officer (OCIO) in which an experienced external advisor assumes responsibility for some or all activities.
- Broader outside advisory. Advisors also need to be capable of taking the enterprise view. Systems that have undergone mergers may find themselves managing multiple pension funds with multiple inherited consultants, many of whom may be limited in scope. Just as with technology, disparate “point solutions” can produce sub-optimal cost and performance.
- Services savings. A good example is custody services. Some track their funds internally. Many employ multiple external custodians. Moving to “consolidated custody” through a single outside vendor opens opportunities for more efficient and cost-effective management.
The menu of investment strategies falls into three main categories: staying risk-averse and mainly in cash, moving some cash to short-term securities and assuming greater investment risk. A brief examination of specific tactics being deployed is instructive.
Creating a portfolio of fixed income investments of varying durations is attractive, as it minimizes interest rate risk, enhances cash flow return and enables timing maturities to milestones, such as repaying the advance Medicare reimbursements. For example, a client with $65 million in advance loans added that amount to its existing $300 million CommerceHealthcare® portfolio. The bank invested the new funds in laddered fixed income investments matching durations to the projected repayment schedule.
An organization can also use laddering within its existing portfolios to generate monthly cash flow to fund operations and augment balance sheet returns. This strategy injects greater stability into planning.
PAY DOWN DEBT
Some financial leaders regard shoring up the balance sheet as the best use of cash given high business uncertainty and a potentially long pandemic recovery horizon.
Replacing high-interest debt with low-interest debt can measurably reduce total annual interest expense. The average pre-pandemic rate for hospital bonds was over 4%. Some non-profit hospitals are finding it advantageous to issue taxable municipal bonds that enable advance refunding of existing higher-rate municipal bonds. The taxable market doubled in 2020 from the prior year and represents nearly 30% of the new-issue municipal market.13
SEEK GREATER RETURN ON FIXED INCOME
Those with greater risk appetite are accepting lower credit quality to improve fixed income returns. Gaining even 50 basis points on $500 million generates $2.5 million annually. Commerce Trust Company is guiding clients toward four asset classes:
- Corporate high yield bonds
- Bank leveraged lending
- Emerging market debt
- Preferred stock and subordinated bonds
ALLOCATE MORE TO EQUITIES AND ALTERNATIVES
Beyond reaching for more fixed income yield, organizations with the appropriate risk proclivities are devoting a greater percentage of cash and unrestricted funds to potentially higher-return stocks. The recent strength of the equity markets demonstrates that even modest steps down this path may be remunerative. Those willing to extend further out on the risk curve are allocating more to alternatives like private equity.
A feature of the enterprise investment analysis is its ability to account for both urgent crisis-related issues and long-term needs. An example of the latter is investment in digital transformation that is vital to achieving the value-based, consumer-friendly care demanded by the market. A recent CFO study revealed that 78% will increase post-pandemic capital spending on digital technologies.14 Another example is cost-saving automation across patient financing, payables and receivables management. Investment decisions in 2021 can have substantial implications on these and other beneficial initiatives.
Each healthcare provider must adapt its investment program to its unique needs. In the face of great uncertainty, CFOs still possess a varied toolkit to try to optimize returns. The enterprise analysis and specific strategies described in this article offer paths for navigating the crisis that merit consideration by all.
- American Hospital Association, Hospitals and Health Systems Continue to Face Unprecedented Financial Challenges Due to COVID-19, May 2020
- Kaufman Hall, National Hospital Flash Report, January 2021.
- Altarum Center for Value in Health Care, “Health Sector Economic Indicators,” Price Brief, December 15, 2020.
- The Physicians Foundation, 2020 Survey of America’s Physicians: COVID-19 Impact Edition, August 2020.
- AHCA and NCAL, State Of Nursing Home Industry: Facing Financial Crisis And Staffing Challenges Fact Sheet, December 2020.
- Definitive Healthcare, “2020 Trend Report Predicting COVID-19’s Long-Term Effects,” blog post, Summer 2020.
- B. Broome, “The Financial Impact of COVID-19 on Health Systems and How CFOs Are Responding,” McKinsey & Company research, June 3, 2020.
- Deloitte Center for Health Solutions, Building Resilience During the COVID-19 Pandemic and Beyond, September 2020.
- Moody’s Investor Service, Moody’s - 2021 outlook for US not-for-profit and public healthcare sector remains negative on constrained revenue, rising costs, December 11, 2020.
- Commonwealth Fund, U.S. Health Insurance Coverage in 2020: A Looming Crisis in Affordability, Survey Brief, August 2020.
- BDO, 2021 Healthcare CFO Outlook Survey, January 2021.
- S. Singhal and C. Repasky, “The Great Acceleration in Healthcare: Six Trends to Heed,” McKinsey & Company blog, September 9, 2020.
- A. Bary, “Yield Plays,” Barron’s, January 4, 2021.
- Deloitte Center for Health Solutions, Building Resilience During the COVID-19 Pandemic and Beyond, September 2020.
The preceding presentation is not a solicitation of any product or investment strategy by the Capital Markets Group (CMG) of Commerce Bank. Any opinions expressed therein are not of CMG. Investments in Securities are NOT FDIC Insured; NOT Bank-Guaranteed and May Lose Value. Commerce Bank and CMG do not act as your ‘municipal advisor’ within the meaning of Section 15B of the Securities Exchange Act, and do not act in a fiduciary capacity. CMG does not provide tax advice; please refer to your tax professional. CMG is not an Investment Advisor nor Portfolio Manager.
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