2016 Investment Considerations for Health Care Organizations

“Though many [health care] providers experienced operating improvement in 2015 as patient volumes grew and cost adjustments were recognized, these organizations still need to focus on care delivery and how it is compensated as well as the effects of health care reform regulation,” says Michael Ancell, National Segment Leader for Mercer Investments. 

“As health care organizations begin 2016, we believe their investment priorities will include assessing and consolidating retirement plans and taking an enterprise level view of their investment strategy and risk management.”

Mercer suggests that not-for-profit healthcare organizations consider the following actions in 2016:

Analyze retirement plans – Did your organization complete a merger during 2015? Some mergers result in multiple defined contribution (DC) and/or defined benefit (DB) plans, which present an opportunity to conduct a complete assessment of their retirement plan design. As the cost of maintaining a DB plan continues to rise, more plan sponsors are considering alternate funding strategies and potential risk transfer opportunities. The trend away from DB plans elevates the need to ensure that an organization’s DC plan is optimized to attract and retain talent.

Define DC investment governance – Recent regulatory attention has focused on DC plan fees and is likely to expand to other areas. Choosing a DC plan’s investment structure and fund lineup is an ongoing task, not a ‘set and forget’ initiative. Investments should be regularly monitored (at least annually), with attention paid to both performance and cost.

Review risk tolerance - Many not-for-profit health care organizations enjoyed solid operating results in the calendar year 2015. As financial metrics improve, the institution’s ability to take more risk may increase as well, so it is a good time to reevaluate risk tolerance and investment strategies.

Integrate investment strategy and financial plans - Most not-for-profit health care organizations are subject to debt covenants that may restrict the amount of investment risk they can take with their unrestricted reserves. Institutions should quantify their risk floor and address it in the investment policy. The risk floor should account for illiquid investment strategies that may be excluded from the day’s-cash-on-hand calculation.

Determine how M&A may affect investment strategy - Not-for-profit health systems that are currently engaged in or considering strategic actions such as mergers and acquisitions (M&A), operating agreement, or joint venture should be aware that some of these actions may materially alter an organization’s balance sheet. Boards may be unwilling to tolerate a significant asset decline post-action. Finance and investment committees should consider how best to integrate investment strategy and whether these factors may necessitate a change in their investment risk profile.

Manage DB funded status volatility - Low interest rates have caused the funded status of many DB plans to remain low the past few years. Funded status is expected to continue to fluctuate based on interest rate activity, investment returns, and plan sponsor cash contributions. As the journey to achieving a fully funded DB plan typically takes years, it showcases the importance of developing a road map to de-risk a plan as funded status improves. This may include allocation adjustments based on preset triggers, plan design changes, fixed income composition changes, and risk transfer methods.

Assess global portfolios’ asset allocation - Investors have remained overwhelmingly invested in U.S. indexes, such as the S&P 500, since the end of the global financial crisis. Those investors have typically been rewarded for riding along with the U.S. Federal Reserve zero interest rate policy and multiple rounds of quantitative easing. The benefits of those policies may have been largely realized in the U.S., resulting in all-time highs for corporate profits as a percentage of gross domestic product (GDP) and above-average valuations. The accompanying strong U.S. equity market returns have led many investors to question their diversified portfolio structure. Organizations should be asking where to look for return opportunities going forward. Additionally, organizations should begin to consider how to balance the more attractive valuations of Europe or emerging markets with the very real challenges faced by both. Health care organizations’ investment committees should think about the how the return on public market beta could potentially be below what is needed to support the mission of the organization.

Audit inflation sensitive investments - Global quantitative easing has supported improved economic growth and market asset prices, but it has not engendered sufficient demand to generate inflation near the 2% target of most central banks. Active foreign currency devaluations have further reduced inflation expectations for U.S. consumers as the stronger dollar drives down the cost of imported goods. Do these changes in global pricing dynamics deserve a policy response from investment committees? Nonprofit committees should think about how to balance the negative impact to inflation-sensitive investments in this low inflation or deflationary trend with the potential inflation surprises.

Review governance structures - Transformation in the delivery of care, coupled with existing operating pressures, requires health care organizations to reduce costs while increasing the quality of care. Outsourcing certain elements of an organization’s investment function can potentially reduce investment expenses and free up staff and committee time to focus on strategy.

Calculate impact of investment grade bonds on returns - Health care organizations’ unrestricted reserves in investment portfolios are typically structured more conservatively than traditional endowments or foundations, which translate to a larger allocation to fixed income investments. Reducing the allocation to U.S. investment grade bonds, while adding to riskier investments, increases a portfolio’s expected return. The tradeoff is that the portfolio’s risk also increases. Higher-rated hospitals with stronger operating margins are better able to absorb unexpected operating challenges and equity market volatility.

Mercer will host a webcast to expand on this topic on Wednesday, January 13, 2:00 to 3:00 p.m. Eastern Standard Time. Register at http://ow.ly/WNEId.